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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.

  • But the mark to market value of the contract from the perspective of the buyer is £-10... – assylias Nov 16 '14 at 0:43
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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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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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