An Introduction to Futures

Futures and forwards are used by firms in the same way in order to manage risk. Futures and forwards simply differ in the manner in which they are traded, and the standardization of the contract.

• In this presentation we'll refer to futures, but much of the content can be generalized to forwards also.

Broadly speaking, there are two types of traders in futures markets, hedgers and speculators.

• Hedgers: Companies who use futures to manage risk. They generally buy futures contract on product they consume, and sell contracts on products they produce.
• Speculators: Individuals and firms who trade futures contracts based on expectations of future prices. This is risk taking behavior.

Speculators play an important role by taking the other side of order imbalances between hedgers. Without speculators, hedgers would have to wait for other hedgers to trade (causing the market maker to widen bid-ask spreads).

Speculators temporarily hold the order imbalance between hedgers in exchange for a return.

Futures markets exist to allow hedging, and not for speculation. That said, without speculators the futures markets would be more likely to fail because transaction costs (bid-ask spread) would increase.

Types of traders and their aggregate positions are summarized in the [CFTC Commitment of Traders Report](http://www.cftc.gov/Marketreports/CommitmentsofTraders/index.htm).

You can automatically import this data for analysis using:

library(readr)
data <- read_csv("https://www.cftc.gov/dea/newcot/c_disagg.txt", col_names = FALSE)
print(dim(data))
## just show first two rows, and first 5 columns
data[1:2, 1:5]

Although we have to add the data headings, which it looks like we can get here.

• CME Group: Comprises the Chicago Mercantile Exchange, Chicago Board of Trade, New York Mercantile Exchange, COMEX, and the CME Europe.
• Intercontinental Exchange
• Chicago Board Options Exchange

CME Soybeans Contract (ZS)

Full Contract Specifications

NYMEX Heating Oil Contract (HO)

Full Contract Specifications

The contract size will give you the profit/loss for a 1 cent movement in the price.

Contracts are marked-to-market daily, and gains and losses are realized.

Maintenance and initial margin are stated in dollars (as opposed to percent). When you open a position you must have sufficient cash to cover the initial margin (initial margin may be the same as maintenance margin).

At the end of each day you have to add cash if your margin amount is below the maintenance margin. If you gained on your contract the case is added to your margin.

All futures prices are affected by interest rates. Beyond that, futures prices are driven by storage costs and convenience yields.

We can take a look at the EIA's Natural Gas Storage Dashboard to start to understand futures pricing.

For convenience sake, we are inexact when we use the term `buy` or `sell` a futures contract. What we mean when we say `buy` (or `sell`) is we enter into contract today to buy (or sell) the underlying at some set point in the future, for the futures price. So when we buy or sell we create a contract, and if we close a position we remove a contract. The number of contracts that are in existence at any point is call open interest.

## Dubai crude oil traded on the Tokyo commodities exchange
dc <- Quandl("TOCOM/33X2018")
head(dc)

library(xts)
oi <- as.xts(dc$`Open Interest`, order.by = as.Date(dc$Date))
plot(oi, main = "Open Interest")

Right now (April 13, 2020) the crude oil market is in contago.

Every month ETFs such as USO have to sell the front-month contract, and buy the following month. They publish these roll dates here:

When the futures market is in contango, these ETFs lose money every month when they roll, and thus destroy value over time.