Quote from: bitdragon on January 16, 2012, 03:42:22 PM

Quote from: realnowhereman on January 16, 2012, 02:27:15 PM

Quote from: Nevermind on July 04, 2011, 08:06:30 AM

A Future contract is an entirely different animal. With a future contract there is no payment upfront either way, it is an outright buy per a date in the future, at a price agreed upon at the outset. Both parties are obliged to fulfill the contract at the end of the agreed upon period.

Hmmm, I'm not a finance guy, so I don't know; but this doesn't sound right.

I thought that futures worked so that you bought something now that the seller doesn't have yet.

The classic example is the farmer. The farmer can sell (say) wheat at $100 a kilo in September; but to do so he needs to spend money now to buy seeds, labour and tools. If he doesn't have that money, he will get $0. A futures buyer offers $90 per kilo right now; giving the farmer the capital he needs to produce the wheat.

i.e. the money changes hands now; the product changes hands in the future.

Have I misunderstood?

The example of the farmer relates more to the uncertainty of the weather and conditions. He does not get paid now, but is guaranteed to get a set revenue in the future. He is setting the future price now, and that price varies as we get closer to the maturity date. The counter risk is that if there is storm that ruins all the crops, the farmer does not go broke but the other one loses out.

Exactly futures don't allow upfront payment of non-delivered goods. I mean can you imagine the counterparty risk of that. Futures just allow you to LOCK IN a futures price.

So in the farmer example say the farmer's cost is $3 per bushel. The current market price is $8 per bushel which would be a record year for the farmer. However the farm has huge risk. He looks out and sees the harvest time futures contract is $7.85 per bushel.

Now the farmer could just do nothing wait till harvest hope it is good and sell for whatever the market price is. What is everyone's harvest is above average and the price plummets by harvest time.

The farmer can lock in revenue stream NOW. He doesn't get the cash now (he doesn't get any cash until settlement) but it protects his future revenue stream. Likewise the baker locks in a price for his raw goods. Granted the price is "high" but the baker may estimate he can still be profitable @ $8 per bushel but if the crop is very bad and prices skyrocket to $20 per bushel he would be ruined.

Futures are simply a way to trade RISK. The farmer and baker are trading RISK. The speculators aren't buying bushels of wheat they are buying RISK. The counterparty to the farmer wins if the crop is worse than expected and prices rise. The counterparty loses if the crop is better than expected and prices fall.

Now if the counterparty had to worry about the farmer delivering that woudl make trading contracts very difficult. Every contract would be different (not fungible) due to different counterparty risk. An exchange requires the farmer to put up a deposit which is "locked" when he sells the contract. This allows the exchange to guarantee the contract and eliminate counterparty risk. Now farmer A contract is equal to farmer B contract and they can simply be traded as "generic" wheat futures. The exchange can also allow buyers to buy with only a fraction of the contract cost. At expiration if the buyer doesn't have the cash to buy the contract in full then he can simply sell it to someone else and still profit from the difference (contract price vs current market price).

So TL/DR
A futures deal only make sense if an exchange exists because the exchange providers counterparty insurance, liquidity, and leverage.