Futures Contracts Explained: An Insight into Futures and Forwards

[@RyanOConnellCFA]

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[@yedster2191]

Been leanrning through one of the world's best professor but still this guys does it better.

[@RyanOConnellCFA]

Wow, that is high praise! I appreciate that a lot. Thank you

[@mahmoudkhan9058]

Very well explained. Thank you

[@mdshahadathossainsajal8373]

Great🎉

[@RyanOConnellCFA]

Thanks 😄

[@rizhawk1628]

Thank you Ryan for making a nice video. Do you have any idea about how many future contracts exchanges like CBOT issues for a particular commodity for a particular period and how they determine it? For example how many Wheat Dec, 2024 (ZWZ24) contracts the exchange (CBOT) has issued? Is there a way to know it?

[@RyanOConnellCFA]

Hello, I'm not sure how to tell exactly how many have been issued. The trading volume data should be pretty readily available which should tell you everything you need to know about a particular contract's liquidity though

[@rizhawk1628]

@@RyanOConnellCFA Volume will be counted many times as same contract is bought and sold every day and in later days.

[@RyanOConnellCFA]

@@rizhawk1628 That is correct, but why do you need to know the number of contracts outstanding for practical purposes? Isn't volume a far better metric in determining the liquidity of a contract?

[@rizhawk1628]

@RyanOConnellCFA If the exchange doesn't issue contracts for trading which should be backed by estimated quantity of the underlying asset then the contracts doesn't have any price relevance with supply of the commodity. Shouldn't fundamentals have impact on price of the future contracts we are trading today?

[@RyanOConnellCFA]

@@rizhawk1628 You've raised a valid point about the importance of fundamentals in determining the price relevance of futures contracts. From my perspective, exchanges like CBOT do regulate the issuance of contracts and ensure they are backed by sufficient assets, maintaining a balance that reflects supply and demand dynamics. This ensures that the futures prices remain closely tied to the actual market conditions and the underlying commodity's fundamentals.

[@arjavjain5671]

very helpful also im aiming to clear frm level 1 in first year of college do u think its possible

[@RyanOConnellCFA]

Thank you! There is no graduation requirement for FRM so you technically could take the FRM Level 1 test in your first year of college. I think it would be quite difficult however as you won't have any finance knowledge going into it. Most universities that I'm aware of do not give you all that many upper level courses of your specific major until year 3. So you would need to be entirely self taught. Self-learning finance at an FRM level of understanding would be very difficult while trying to manage a full course load on the side. Personally, I wouldn't take FRM Level 1 in my first year of college. You would likely end up burnt-out and overworked. College is supposed to be a fun time for most people anyways, try to enjoy it. That's just my opinion though

[@arjavjain5671]

@@RyanOConnellCFA thank u for the advice means alot sir

[@RyanOConnellCFA]

@@arjavjain5671 Its my pleasure!

[@yedster2191]

Hi, so i had a follow up to this topic. 1. In future contracts, as you said how is delivery usually settled in cash. like doesn't either one of the party pay in physical goods. 2. In future contracts, I get 1 barrel of oil each day and pay for 1 barrel of oil each day only with the price adjusted for oil according to that day? And whereas in forward contract, I pay for the entire contract of 1000 barrels of the day I get the final batch of barrel, even though I was getting some barrels daily? 3. if you don't mind can you give another simple example of future contracts.

[@RyanOConnellCFA]

Hey! 1. By settled in cash, I mean they do not pay in physical goods. One pays the other an amount strictly in cash that is equal to the amount that they were down in contract value 2. In futures contracts, you typically settle the entire contract value at the end of the contract period, not daily. Futures are standardized and marked-to-market daily, meaning gains or losses are settled daily in cash, but the actual delivery (if opted for) occurs at the contract's expiration. In contrast, forward contracts are customized agreements where the entire payment and delivery are settled at the end of the contract, with no daily settlements. 3. A simple example of a futures contract is a farmer agreeing to sell 1,000 bushels of corn at $4.00 per bushel for delivery in three months. Regardless of market price fluctuations, the farmer will deliver the corn and receive $4,000 (less any daily gains or losses already settled) at the contract's expiration. This protects both the farmer and the buyer from adverse price movements.

[@yedster2191]

@@RyanOConnellCFA 2. So in this point, does it mean that according to today’s rate the contract’s price will be changed. And nothing else happens to the contract ? Thank you for your response.

[@yedster2191]

@@RyanOConnellCFA 3. In this point, does it mean that in forward contract I would just be given $4000 but in futures contract, I would be given the adjusted price according to the gain or loss from my initial principal value in contract. So how do they settle the losses and gains in futures contract? Do they add the gain or subtract the loss from the principal value at that time’s inflation?

[@victoricus1]

Ryan, hi. Can you please explain the following concept to me - when interest rates and and futures prices are positively correlated, futures are more attractive than forwards...is it because the initial interest rate which is set in a contract is lower than a hypothetical current rate, and you kinda get excess gains as a result of the MTM process? So you win because you bet on a lower rate, but when it actually gets higher, you sorta economise and gain from that?

[@RyanOConnellCFA]

You've got the right idea here. When interest rates and futures prices are positively correlated, and interest rates rise, the value of futures contracts tends to increase due to the daily MTM process. Forward contracts are not marked to market daily, and their value is locked in at the initiation of the contract. So, if you have entered into a futures contract betting on a lower rate, and then the rate rises, the MTM process allows you to realize gains on a daily basis, which can then be reinvested at the higher current interest rate. This creates a compounding effect, making the futures contract more attractive compared to a forward contract in such a scenario.

[@victoricus1]

@@RyanOConnellCFA wow, that was a quick reply) thank you) so it can be used as an alternative to, say, vanilla bank deposits where rates are fixed and you can potentially earn more by not investing in a contract with a fixed rate (i.e. bank deposit)?

[@RyanOConnellCFA]

@@victoricus1 Absolutely! Futures contracts can serve as an alternative to traditional fixed-rate bank deposits, especially in rising interest rate environments where the potential for earning more through futures exists due to the daily marking-to-market and reinvestment of gains at higher rates. However, the potential to earn more comes with added risk. The higher risk, higher return rule that's universal in finance applies to this situation as well

[@victoricus1]

@@RyanOConnellCFA thank you

[@RyanOConnellCFA]

@@victoricus1 My pleasure