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Assume a future contract specifies that the holder of the contract will need to buy corn from XYZ farm at £100 per tonne, 1 tonne. So total deal value when realizing this contract is £100.

We all know the contract can then be sold in the market before expiry, and the price can fluctuate.

Here's the thing I don't understand: A future contract is essentially a non-optional call option. The contract IS the guarantee that the trade will take place at £100. Assume the last spot for corn is £90 per tonne. You know, once the contract is written, you can't erase the £100 per tonne strike on the future contract. Therefore, the market value of this contract, right before the last trading second, is supposed to be £-10 because the holder of the contract is going to pay £10 pound than the market value to buy corn from XYZ farm. But things like this never happen - future contracts never have negative prices.

So ... which link in the chain of my understanding broke?

Please enlighten me.

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  • But the mark to market value of the contract from the perspective of the buyer is £-10...
    – assylias
    Nov 16 '14 at 0:43
  • Related question: Time decay of futures
    – nanoman
    Nov 9 '21 at 6:29
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A future contract is essentially a non-optional call option.

I can see why you might think this, but is not accurate. I recommend you do not retain this mental model.

Therefore, the market value of this contract, right before the last trading second, is supposed to be £-10

No, the value is 90. The price of the contract is 90. Your PnL, is -10.

But things like this never happen - future contracts never have negative prices.

Futures contracts, and indeed many commodities and other assets and contracts can and do have negative prices. My garbage has a negative price to me, as I pay someone to take it from me.

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No great mystery here. You're absolutely correct, the value of this Future is now negative. The reason that you don't see Futures for sale at negative prices is that they have no value. It's the same with an Option which is out of the money, the option is now worthless and the holder will just let it expire. To attempt to sell it would be foolish, as no-one will buy it.

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  • This is a contradiction. Can not have negative value and "no value". Reason is surely that futures are just settled and rolled/collapsed into a strike that gives zero PV no?
    – mathtick
    Mar 16 '20 at 10:32
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The missing link in the chain is that futures contracts do not specify the price that the owner of the contract will pay for the underlying asset. The price of the contract itself is how much its owner pays for delivery of the asset.

Following your example, the contract would be to deliver 1 tonne of corn on a certain date. The price you pay to buy the contract is how much you'll spend in total to have that 1 tonne of corn delivered to you on the expiry date.

So, to guarantee that you'll pay exactly $100 for 1 tonne of corn, you would buy 1 contract when it trades at $100. The contract writer gets $100 and you pay nothing on the expiration date to take delivery. In essence, you paid for the corn up front. If the price of corn goes down to $90 on the expiration date, the price of the futures contract would also be $90.

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  • This is not correct. You don't "buy" a futures contract - you enter into a contract to buy something at a specific price in the future. No money is exchanged upfront.
    – D Stanley
    Nov 9 '21 at 14:16
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You are wrong in that a future contract is not an option contract. It has no strike, and the future contracts value is not a premium as there is no premium. Imagine you order a PS5 online and it will be delivered to you in one month for a fixed price of $500. You pay $50 as an initial margin and get a contract. In one month the price rises to $1000 and you changed your mind on buying a PS5 and sell the contract to your neighbor for $1000, because you can go and get the PS5 and sell it for that price. So therefore a contract is worth as the underlying with nuances (see last sentence) Now notice that after selling, your return is 1000/50=20X. If you used all $500 dollars and sold after a gain, you would pocket $10000 But you would be margin called if it droped 10% from your initial buy of 10 PS5's for $500 each or just $50. This is ignoring costs that your seller will keep the PS5 for you until delivery. Those can make futures go negative.

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You're confusing the value of the contract with the futures price. The futures price is set by the market - meaning it's whatever contract price you can get someone else to take the other side of. It is set for the life of the contract.

As other futures contracts are traded, though, the value of your contract goes up and down (and yes, becomes negative). If the market price goes down, you are locked in to buying at a higher price, therefore your contract has a negative value.

You don't see "negative prices" like this because these contracts are not traded. The price you see quoited is the price at which you can enter into a new futures contract. When you enter or exit a position, you create a new contract at a new price. The exchange then settles with you any difference in value. So if corn prices drop to £90 and you want to exit your position, you would enter into a new position to sell corn at £90, cancelling out your buy position, and you'd settle up the £10 with the exchange.

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