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Yes many futures are not "cash settled" but settled in the actual commodity. This is why in rare occasions the price of a thing goes negative because trading i

Yes many futures are not "cash settled" but settled in the actual commodity. This is why in rare occasions the price of a thing goes negative because trading in that thing you are contractually obligated to take delivery and people trying to unload that obligation sometimes can't find buyers until they are paid to take delivery. It happens when nobody really wants to buy a thing and there is no capacity left to store or ship. When you buy a futures contract and you don't want delivery you have to sell it to close your position, and rarely you have to give people large sums of money so you can close.

tialaramex 2y ago
In 2020 some Oil futures were negative at close, which has one obvious effect (if you're stuck holding the bag you're paying to store all this oil despite it being, at least temporarily, worthless) but also messes up the ETFs. Suppose my actual oil futures go from $800k to $900k, the ideal ETF is trying to ensure that $800k also turns into $900k just as if its investors were in actual oil futures. But these aren't futures and don't result in delivery - so critically when real oil futures blow up and that $900k turns into -$1M because the global economy had a heart attack the ETF cannot be worth -$1M as it's just paper and I don't have to pay you one cent. For the ETFs this means a negative exposure for the operator - they're eating unlimited downside but can't pass that on to their customers, and for a blip like 2020 that's survivable (if you're well capitalised) but longer term it would be fatal.
- chii 2y ago
  i figured these ETF providers have to have sufficient capital in reserve to allow for it perhaps? I mean, how does it work if they defaulted on those options by not being able to take delivery? Who pays?
  - tialaramex 2y ago
    Some ETFs can't go negative because they're moving say, stock in oil refiners, oil research, etc. and they've got a model to try to follow the motion of oil futures based on investments in those stocks. So for them this sort of chaos is not good of course, but they don't have scary red numbers everywhere and people who might jump out of a window. In some cases there is basically a bucket shop (hopefully not literally, those are illegal) and so you're betting against somebody with lots of capital, but in that scenario it can definitely go very bad and it's important to read your fine print. I believe in 2020 some funds pointed out that in their fine print it said they get to choose not to follow a month's oil delivery if they need to, so, you expected $15M for the June oil because it went negative as you'd hoped, but too bad we've decided to roll that over to July oil, and that's going to lose you money as you have to wait a month longer and get worse results. That sort of thing is obviously infuriating for an investor, but as with gambling firms who won't pay (and this happens a lot if you win serious money gambling, e.g. Oops, when you gave us $100 we forgot to ask for valid ID, but now that we owe you $150 000 because you got lucky we've remembered - without ID actually the bet was illegal, so here's the $100 back and no hard feelings) they get a reputation for not paying and that does eventually hurt them.
- detaro 2y ago
  > which has one obvious effect (if you're stuck holding the bag you're paying to store all this oil despite it being, at least temporarily, worthless) Isn't it the other way around? Because you would be stuck holding the bag the prices went negative?
  - tialaramex 2y ago
    I guess it depends how you look at it, the two things are intertwined.
- LittleTimothy 2y ago
  It's also a head-ache for options traders because some options models (black scholes) have log-normal pricing baked in which don't actually allow for the underlying asset to go negative. So nevermind worrying about taking delivery, your HFT options desk just had their algo blow up.
  - wbl 2y ago
    Nah your desk closed out as the model was starting to choke.
  - heavenlyblue 2y ago
    Looks like they just need to use complex numbers in their calculations?
Marazan 2y ago
> Yes many futures are not "cash settled" but settled in the actual commodity. This, in many ways is a ridiculous sentence which shows what is wrong with the futures market. Futures are contracts for the supply of commodities. All futures should be settled by the actual commodity! That we have got to a situation where the vast majority of futures contracts are just 2nd order bets on the price of thing rather than delivery of the thing is non optimal.
- frontfor 2y ago
  I’m not sure about “vast majority”. Barring some exceptions (e.g. lean hogs), many of the commodities futures are physically delivered (e.g. gold, silver, copper, corn, wheat, soybean, natural gas, live cattle). Financial futures like S&P 500, 3-month SOFRs are obvious financially settled as they don’t correspond to anything physical.
- kqr 2y ago
  This comment shows what is wrong with people's understanding of futures markets. Commodity futures are not for the supply of commodities. If you need a supply of commodities, cash contracts are your thing. Futures, specifically, are useful for implicitly borrowing commodities to control inventory levels across time. An airline needs continuous access to jet fuel, so to be safe, they buy more jet fuel than they need in the cash market. But they don't want to pay for owning all this jet fuel, so they simultaneously sell it off in the futures market. Thus, they have created a loan of jet fuel, making sure they have spare fuel available when they need it without outright having to own it. In order to have a loan, one needs a speculator willing to buy the credit risk. More speculators usually leads to more liquidity and more accurate deals on loans. There's nothing wrong with this at all. See The Economic Function of Futures Markets by Williams (1986) if you are curious.
  - keepamovin 2y ago
    It would be good if you could do this with cloud capacity.
    - 2y ago

tialaramex 2y ago

In 2020 some Oil futures were negative at close, which has one obvious effect (if you're stuck holding the bag you're paying to store all this oil despite it being, at least temporarily, worthless) but also messes up the ETFs. Suppose my actual oil futures go from $800k to $900k, the ideal ETF is trying to ensure that $800k also turns into $900k just as if its investors were in actual oil futures. But these aren't futures and don't result in delivery - so critically when real oil futures blow up and that $900k turns into -$1M because the global economy had a heart attack the ETF cannot be worth -$1M as it's just paper and I don't have to pay you one cent. For the ETFs this means a negative exposure for the operator - they're eating unlimited downside but can't pass that on to their customers, and for a blip like 2020 that's survivable (if you're well capitalised) but longer term it would be fatal.

chii 2y ago
i figured these ETF providers have to have sufficient capital in reserve to allow for it perhaps? I mean, how does it work if they defaulted on those options by not being able to take delivery? Who pays?
- tialaramex 2y ago
  Some ETFs can't go negative because they're moving say, stock in oil refiners, oil research, etc. and they've got a model to try to follow the motion of oil futures based on investments in those stocks. So for them this sort of chaos is not good of course, but they don't have scary red numbers everywhere and people who might jump out of a window. In some cases there is basically a bucket shop (hopefully not literally, those are illegal) and so you're betting against somebody with lots of capital, but in that scenario it can definitely go very bad and it's important to read your fine print. I believe in 2020 some funds pointed out that in their fine print it said they get to choose not to follow a month's oil delivery if they need to, so, you expected $15M for the June oil because it went negative as you'd hoped, but too bad we've decided to roll that over to July oil, and that's going to lose you money as you have to wait a month longer and get worse results. That sort of thing is obviously infuriating for an investor, but as with gambling firms who won't pay (and this happens a lot if you win serious money gambling, e.g. Oops, when you gave us $100 we forgot to ask for valid ID, but now that we owe you $150 000 because you got lucky we've remembered - without ID actually the bet was illegal, so here's the $100 back and no hard feelings) they get a reputation for not paying and that does eventually hurt them.
detaro 2y ago
> which has one obvious effect (if you're stuck holding the bag you're paying to store all this oil despite it being, at least temporarily, worthless) Isn't it the other way around? Because you would be stuck holding the bag the prices went negative?
- tialaramex 2y ago
  I guess it depends how you look at it, the two things are intertwined.
LittleTimothy 2y ago
It's also a head-ache for options traders because some options models (black scholes) have log-normal pricing baked in which don't actually allow for the underlying asset to go negative. So nevermind worrying about taking delivery, your HFT options desk just had their algo blow up.
- wbl 2y ago
  Nah your desk closed out as the model was starting to choke.
- heavenlyblue 2y ago
  Looks like they just need to use complex numbers in their calculations?

Marazan 2y ago

> Yes many futures are not "cash settled" but settled in the actual commodity. This, in many ways is a ridiculous sentence which shows what is wrong with the futures market. Futures are contracts for the supply of commodities. All futures should be settled by the actual commodity! That we have got to a situation where the vast majority of futures contracts are just 2nd order bets on the price of thing rather than delivery of the thing is non optimal.

frontfor 2y ago
I’m not sure about “vast majority”. Barring some exceptions (e.g. lean hogs), many of the commodities futures are physically delivered (e.g. gold, silver, copper, corn, wheat, soybean, natural gas, live cattle). Financial futures like S&P 500, 3-month SOFRs are obvious financially settled as they don’t correspond to anything physical.
kqr 2y ago
This comment shows what is wrong with people's understanding of futures markets. Commodity futures are not for the supply of commodities. If you need a supply of commodities, cash contracts are your thing. Futures, specifically, are useful for implicitly borrowing commodities to control inventory levels across time. An airline needs continuous access to jet fuel, so to be safe, they buy more jet fuel than they need in the cash market. But they don't want to pay for owning all this jet fuel, so they simultaneously sell it off in the futures market. Thus, they have created a loan of jet fuel, making sure they have spare fuel available when they need it without outright having to own it. In order to have a loan, one needs a speculator willing to buy the credit risk. More speculators usually leads to more liquidity and more accurate deals on loans. There's nothing wrong with this at all. See The Economic Function of Futures Markets by Williams (1986) if you are curious.
- keepamovin 2y ago
  It would be good if you could do this with cloud capacity.
  - 2y ago