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I have little knowledge about futures contracts. The recent negative price of crude oil spurred my curiosity about this stuff.

I read this post about buying/selling futures contracts. According to this post, when I buy a futures contract, I enter into a contractual agreement to buy some commodity on some future date, and I only need to pay a 2% initial margin.

Suppose the price of the commodity does not fluctuate but I change my mind and decide not to buy the commodity at maturity. What punishment could be exerted on me?

I do not want the 2% initial margin back because that is a little money compared to the real value of the commodity. If there is no extra penalty, it would be unfair for the seller — imagine the seller transports 1000 barrels of crude oil to your front door and you say "I do not need it any more, please take it away, thank you!"

Update: I did more research about this and have more questions.

If I buy a futures contract at $10 and the price of the contract drops to -$37 at the last trading day, at which price should I buy the commodity at the delivery day, $10 or -$37?

There seems not just one contract I enter into when I buy a futures contract: the original futures contract between me and the seller of the commodity(or the exchange?), the contract between me and my brokerage, the contract between the brokerage and the exchange. I'm not clear about the exact entities of each contract and the obligations involved in each contract. The contracts seem contradictory with each other, e.g., my brokerage may forcefully sell my futures contract if my account balance is not enough, which will prevent me from fulfilling the obligations in the futures contract, i.e., receiving the commodity on future date.

If I(or an institutional trader) trade directly (not via a brokerage) with an exchange(does CME accept individual traders?), does the exchange have the rights to forcefully sell my contracts at the last trading day at any price or close my position at the settlement price(say -$37)? If the exchange does so thus letting me own $5,000M to it, is it more justice for me to sue the exchange rather than let the exchange sue me? If I could hold the position, the loss caused by my not executing the delivery/receipt of the commodity may be less than $5,000M. Of course, the loss will be determined by the court, not by the exchange according to the settlement price formed by itself or a few possible conspirators.

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    The opposite of Repo Man would show up at your door.
    – copper.hat
    Commented Apr 28, 2020 at 5:02
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    If the price did not fluctuate, why not just sell your contract to somebody else who does want to buy?
    – user12515
    Commented Apr 28, 2020 at 6:41
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    That does sound like the description of the preceding events to this story here: thedailywtf.com/articles/special-delivery ;-)
    – orithena
    Commented Apr 28, 2020 at 10:59
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    What happens if you don't honor any legally enforceable contract?
    – Michael Benjamin
    Commented Apr 29, 2020 at 4:29
  • 3
    If you want to ask more questions, ask more questions (as separate questions on stackexchange) instead of editing them in this one.
    – Peteris
    Commented Apr 29, 2020 at 9:23

3 Answers 3

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A futures contract is legally enforceable just like any other contract so the entity at the other end of the contract will have every right to sue you, extract fair recourse per the contract, and quite likely damages as well. In addition, you will very likely never be able to trade again on that exchange as your credit/performance risk would be deemed too high. (Quite similar to if you signed a lease contract with a landlord, and decided to say "I'm not paying rent this month, thank you!")

Per your specific example, if you executed that trade via a brokerage there is a next to zero chance you hold it to expiry as they should liquidiate it on your behalf close to expiry. If you were an institutional trader, defaulting on taking delivery on a trade wouldn't be a decision considered outside an extreme liquidity crisis or bankruptcy scenario...and it would result in the penalties mentioned above which would have far-reaching implications for any trading organization.

Also note that margin requirements are periodically adjusted for market volatility (currently much higher for crude oil), and that a 2% margin is on the extreme low end of margin requirements. In addition there are lots of cash settled contracts where profit/loss is credited/debited from your account without a physical delivery scenario arising.

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    Their ability to liquidate it requires there to be a buyer for it.
    – David Schwartz
    Commented Apr 28, 2020 at 20:44
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    @DavidSchwartz The recent events demonstrate there's always a buyer at some price.
    – chrylis -cautiouslyoptimistic-
    Commented Apr 29, 2020 at 5:16
  • @chrylis-onstrike- People posted errors they've never seen before -- market orders failing because of a lack of orders to match them to. There were times when some marketplaces for some oil futures had literally no buyers.
    – David Schwartz
    Commented Apr 29, 2020 at 5:44
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    @DavidSchwartz, no futures market guarantees instant liquidity for any position size on any part of the forward curve. For retail brokerage accounts this is much less of an issue since their activity is usually of relatively small size in the most liquid part of the curve. However, i'm at a loss when you say marketplaces for oil futures (in the recent negative price event i'm guessing) had no buyers. Which marketplaces specifically?
    – WittyID
    Commented Apr 29, 2020 at 10:14
  • "In addition there are lots of cash settled contracts where profit/loss is credited/debited from your account without a physical delivery scenario arising." - almost all futures contracts have daily variation margin, not just cash settled. Cash / physical settlement specifically refers to final settlement only.
    – ThatDataGuy
    Commented Nov 21, 2020 at 19:00
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The contract specifies the delivery, generally it is for the buyer to arrange for transport to his location. If the buyer doesn't pick up from the location, he is hit with warehouse charges and the goods are auctioned. The buyer has to make up for the extra payment enforced by the broker... So it's not 2% loss, it can be more. On large contract broker would have sufficient collateral from buyer to safe guard his interest else the broker looses...

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Margin

Not only do you have to pay an initial margin, but also further margin calls should the price of the underlying drop below the maintenance level:

https://www.thebalance.com/all-about-futures-margin-on-futures-contracts-809390

Delivery

Regarding delivery, all futures contracts with delivery (as opposed to purely electronic settlement, such as with S&P futures) specify where delivery will take place. For the NYMEX WTI Crude Oil Future, that is Cushing, Oklahoma. Delivery is Free On Board, so you don't have to pay for delivery; @Dheer must be quoting another contract.

https://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude_contract_specifications.html

Settlement

Regarding your further questions: Cash settlement of the future takes place at settlement date at the price you bought the future, that's the point of futures. I

If your broker sells your contract, then the buyer enters into the obligation to receive delivery. This can happen during the life of the contract anyway, if you decide to instruct your broker to close out your position.

CME Membership

The CME accepts individual members ($400,000) per seat, and also allows you to lease seats: https://www.cmegroup.com/company/membership/individual/cme.html#becomeAMember

You are required to disclose your financial situation: https://www.cmegroup.com/company/membership/files/CMEGroup_Long_Form.pdf

Default

Regarding your last comment:

"Of course, the loss will be determined by the court, not by the exchange according to the settlement price formed by itself or a few possible conspirators."

The settlement price is not determined by the exchange, except insofar as in the original contract terms. You have to settle at the contracted futures price. The value of the contract at settlement is not the settlement price. For futures in liquid markets and normal times, the contract value will be the spot (current) price of the underlying. The contract price is set at the time of purchase and is set so that the future has zero value at time of purchase, which is why you only need to pay an initial margin.

As others have pointed out, breaching a futures contract has legal consequences. The CME requires institutional members to contribute to a fund to cover defaults by counterparties, as do all futures exchanges. These members and the exchange will sue to recover their losses.

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