- Jan 2, 2006
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From what I understand, a future is simply a contract stating that you'll buy or sell a certain thing at a certain time in the future for a certain amount of money.
An example of a commodities future:
You and Bob enter into a contract stating that you'll buy 10,000 kilos of coffee from Bob in two months for $10,000.
At this time no money or coffee actually exchanges hands.
After two months, you give Bob $10,000 and Bob gives you 10,000 kilos of coffee.
After two months, if the selling price of coffee is $2/kg, you just scored a great deal on your gamble on the future price of coffee because you bought at $1/kg (and can re-sell for $2/kg) and Bob is at a loss (because he could have sold to someone else at $2/kg). On the flip side, if coffee is $0.50/kg, you're obligated to buy at Bob's $1/kg price, so now you've got 10,000 kilos of coffee sitting around somewhere that you bought at $1/kg, but you can only re-sell it at the current market price of $0.50/kg.
The part that I don't understand is how does this all work for the common trader sitting at a computer?
If I enter into a futures contract and two months later spend money at the agreed-upon price on the agreed-upon items, do I then physically own that item? Do I actually have 10,000 kilos of coffee sitting in a warehouse somewhere, requiring the payment of daily warehouse fees and the threat of spoilage after a month unless I can re-sell all that coffee? What's actually going on in the background?
Or is a futures contract simply a bet on the price of an item, not on the item itself? So two people who have absolutely no connection to coffee and have zero physical stores of coffee simply enter into a bet that states they'll pay each other money at whatever market price coffee happens to be at at a certain point in time?
An example of a commodities future:
You and Bob enter into a contract stating that you'll buy 10,000 kilos of coffee from Bob in two months for $10,000.
At this time no money or coffee actually exchanges hands.
After two months, you give Bob $10,000 and Bob gives you 10,000 kilos of coffee.
After two months, if the selling price of coffee is $2/kg, you just scored a great deal on your gamble on the future price of coffee because you bought at $1/kg (and can re-sell for $2/kg) and Bob is at a loss (because he could have sold to someone else at $2/kg). On the flip side, if coffee is $0.50/kg, you're obligated to buy at Bob's $1/kg price, so now you've got 10,000 kilos of coffee sitting around somewhere that you bought at $1/kg, but you can only re-sell it at the current market price of $0.50/kg.
The part that I don't understand is how does this all work for the common trader sitting at a computer?
If I enter into a futures contract and two months later spend money at the agreed-upon price on the agreed-upon items, do I then physically own that item? Do I actually have 10,000 kilos of coffee sitting in a warehouse somewhere, requiring the payment of daily warehouse fees and the threat of spoilage after a month unless I can re-sell all that coffee? What's actually going on in the background?
Or is a futures contract simply a bet on the price of an item, not on the item itself? So two people who have absolutely no connection to coffee and have zero physical stores of coffee simply enter into a bet that states they'll pay each other money at whatever market price coffee happens to be at at a certain point in time?
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