What are futures? How does the futures market work?

In a traditional transaction, we would pay one hand and deliver the goods the other. This is called a spot transaction. Futures are a contract signed now but traded in the future.

For example, Saburo was a seller of rice balls during the Edo period, but recently the atmosphere of war has become more and more intense. Saburo is worried that the war will cause the price of rice to soar, and that he will not have enough money to buy rice to make rice balls. So Saburo decided to use the current price to buy the future batch of rice with the rice merchant before the next season's white rice harvest! So Saburo paid a deposit to the rice merchant and signed a contract to "buy future white rice", which is the predecessor of futures.

The biggest difference between futures and spot is that

• Margin

• Margin same-day settlement

• Physical delivery is usually not required after expiration

Just remember these three points to understand futures well.

Security deposit: Saburo wants to reserve rice for three months, so he and the rice merchant agree to buy a ton of rice at a price of 1000/ton after three months, and sign a contract. Neither Saburo nor the rice merchant has paid a deposit (security deposit).

Three months later, the price of rice fell to 950/ton. Saburo thought that if he didn't fulfill the contract and bought rice from someone else, he could get 50 cheaper, so he decided to default and buy rice from someone else. As a result, Saburo made 50, while the rice merchant lost 50. Because Saburo did not pay the security deposit when signing the contract, the rice merchant had to bear the loss himself.

In order to ensure that the breach of contract did not happen, Saburo and Mi Shang decided to take out a certain percentage of the total amount of money as a security deposit when signing the contract and hand it over to the village chief for notarization. No matter which party breached the contract, the security deposit would belong to the other party.

Therefore, Saburo and the rice merchant happily signed a contract and each took out a deposit of 10% of the total amount, which is 100%. There should be no problem now, right?

Three months later, the price of rice fell to 500/ton. Saburo thought that if he defaulted, he would lose 100% of the margin, but he could buy rice 500 cheaper, and still make 400 in total, so Saburo chose to default again. Because the margin paid by Saburo when signing the contract (100) was not enough to make up for the loss of the rice merchant (500), the rice merchant had to bear the loss himself.

That is to say, the margin system alone cannot prevent the phenomenon of default.

In order to better allow both parties to fulfill the contract, the village chief came up with a second method, which was the same-day settlement system for the deposit.

From the beginning, Saburo and the rice merchant signed a contract, and Saburo and the rice merchant each paid a deposit of 100.

Who would have thought that as soon as the first day passed, the price of rice would drop to 900/ton. The village chief thought that Saburo's loss was now the same as the security deposit. If the price of rice fell again tomorrow, Saburo would definitely default. So the village chief deducted 100 from Saburo's security deposit, handed the 100 to the rice merchant, and updated the content of the contract to three months later, Saburo paid the rice merchant 900 to buy 1 ton of rice.

Saburo calculated and found that the village chief's actions did not affect his interests.

The rice merchant also calculated and found that the village chief's actions did not affect his own interests.

However, Saburo found that his deposit was already 0. In order to continue to fulfill the contract, he had to make up a deposit of 10% of the contract amount before tomorrow, which is 900 x 10% = 90.

After Saburo pays the deposit, if the price of rice continues to fall tomorrow, the village chief will repeat the above practice to ensure that the two sides cannot avoid losses by defaulting.

After two months, Saburo's onigiri shop closed down due to poor management. At this time, the price of a ton of rice was still 1,050/ton. Saburo thought to himself: he no longer needs this ton of rice, and there is no reason to fulfill the contract, but if he chooses to default, he will lose 100% of the margin. How can this be good?

As it happened, Saburo's neighbor Yoshinaga opened a restaurant. Yoshinaga wanted to book rice for a month, so the village chief brokered a contract between Yoshinaga and Saburo, stipulating that after a month, Yoshinaga would pay Saburo 1050 to buy 1 ton of rice.

Saburo offset the futures contract to buy rice by signing a futures contract to sell rice, without physical delivery, and made a net profit of 50.

Saburo found that he only needed to use 10% of the amount to make a trade, which made the profit fluctuate greatly. Saburo began to learn to buy rice futures at low prices and sell rice futures at high prices. He became a speculator and has since reached the peak of his life.

Summarize:

Saburo bought rice futures → build a position

Saburo holds the futures of rice until the contract expires → holds a position

When the contract expires, Saburo pays for rice → delivers

Before the contract expires, Saburo sells this contract (meters) to others → position squaring