1

I get the idea of future trading and its original purpose. However, I cannot quite understand how things work when traders and speculators are involved. For example, lets say a producer actually wants to lock in a price for his product so he bought a future contract that matches his goal. What would happen if the counter party closes their position prior to the expiry date? Wouldn't the producer be left with his product and thus not able to sell at the price he intended to? Assuming he does not also closes his account prior to the expiry date, who is the counter party that is ready to buy the product in the end?

In short, doesn't speculators and trader disrupt trading for those who actually want to trade commodity physically by moving prices up and down? My only theory is that producers and manufacturers rarely uses the future exchange and when they do its to hedge the procurement contract they already have in hand, so any gains or losses in the futures can be offset. Is this correct?

  • Hi new user! The simple answer can be given in four words. The traders provide liquidity. Other wise there wouldn't be anyone to buy to sell to at any time! But I fear the question is way too broad and philosophical - simply, nobody knows the answers to such deep questions. You might as well ask which way to vote in a national election - you know? Any answer you get will just be one common theory! – Fattie Nov 23 '18 at 3:08
  • OP, you realize many contracts are, in fact, "cash settled" ? – Fattie Nov 25 '18 at 14:24
1

What would happen if the counter party closes their position prior to the expiry date?

In an orderly market (i.e. real futures, not some future like contracts), the counter party is not the speculator, it is the EXCHANGE. If the speculator closes his position, he closes it against another buyer/seller factually, but legally he closes his contract with the exchange. Which means that the other side does not even realize a contract is closed.

When delivery time comes, the oldest contracts in existence are delivered to first.

Also, you ignore that in most cases noone wants to move physical goods. See, you also do not trade physical goods with your counterparty (which you do not know) but with the exchange. If you are a southern USA part wheat farmer, why would you ship the wheat to the Exchange in Chicago (which you can) instead of selling it locally to another company specialized in moving it? MOST people, including those handling the good, actually do close out contracts and use the financial offset but handle the goods in another way. They use it for hedging. Often with legal requirements (as hedging reduces market exposure).

1

You're asking about this scenario:

  1. The producer buys a put option for something he produces, with the put option priced at $p and the product priced at $q.
  2. The counter-party of the put option closes the position.
  3. Who does the producer now sell to?

Normally, closing a derivative position leads to two positions, not zero:

As we discussed previously, when a trader goes long or short on a position, he can close his position prior to expiration by executing a reversing transaction that is exactly the same as his original trade. The clearing house views the trader as holding a long and short position that offset each other, causing the trader's position to be flat. This is the same as having no position at all. - investopedia

That is, the counter-party is still on the hook for the original contract in step 1 above, so the farmer's contract remains intact (price, quantity, etc). What step 2 does is provide the (original) counter-party with their own counter-party who would buy the goods, possibly at a different price, say $r.

The producer is not party to the transaction at price $r, so the counter-party's secondary position doesn't affect the producer at all. This achieves his original goal of having a buyer at a definite selling price and time.

-1

Not that I know that much about futures but your premise is confusing. A producer would buy a contract to acquire the raw materials at a given price. He would then manufactured his product which would be sold elsewhere (wholesale or retail). It would not be sold via a futures contract.

Be that as it may, if the producer (A) buys and owns the contract for which the seller was (B) and (B) then decides to close his position, it is purchased by (C) who is becomes the counter party to (A) whose position is unchanged. In the interim, after (C), many traders may buy and sell the same contract while (A) continuously remains the long side of the trade. Only a buyer and a seller executing closing transactions would make the contract disappear (BTC + STC).

  • Thanks for the comment. Sorry I was not clear in the original post. What I meant by the producers are simply the farmers or oil extractors looking to sell theri corn, oil to manufacturers who produces the final products. Nonetheless, what I was trying to say is what happen when the producer or manufacturers (one is lookng to lock a price to sell, the other to buy) is paired with speculators who have no intention of physical delivery? – user79060 Nov 23 '18 at 5:48
  • Also, if they do not close their position, (since they actually want to sell/buy the commodity) what would happen to their counter party who is stuck to the contract (assuming it is delivery date so they cannot close their position in time)? Thanks! – user79060 Nov 23 '18 at 5:48

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .