How is it possible for a Futures contract to have an intangible underlying? For example, to my knowledge, there exist Futures that have interest rates as their underlying, come delivery date, how is the seller suppose to "deliver" interest rates?
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It's just cash settled, like a bet on a sports game. This was somewhat controversial when the financial index futures were first invented.
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$\begingroup$ Right, because Futures can be settled with cash also. Thank you. $\endgroup$ – Jeel Shah Feb 5 '13 at 15:23
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Examples for cash-settled futures are:
- Interest Rate futures
- Futures on implied Volatility (e.g. on VIX)
- Futures on Commodity Indices: Indices such as the Dow Jones UBS consist of futures themselves. Furthermore in asset management you usually don't want physical delivery of the underlying (oil, gas, coal, pig, ... ;)
- Futures on Equity Indices
The pricing and the risk models differ for all these depending on whether you can trade the underlying or not. With VIX it becomes especially tricky.
