Comment by colechristensen

tialaramex 20 hours 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.

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LittleTimothy 17 hours 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.

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- wbl 13 hours ago
  
  Nah your desk closed out as the model was starting to choke.
  
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- heavenlyblue 13 hours ago
  
  Looks like they just need to use complex numbers in their calculations?
  
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chii 20 hours 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?

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- tialaramex 16 hours 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.
  
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detaro 18 hours 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?

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- tialaramex 17 hours ago
  
  I guess it depends how you look at it, the two things are intertwined.
  
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Marazan 19 hours 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.

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kqr 18 hours 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.

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- potato3732842 16 hours ago
  
  Man, it's hilarious how you managed to go full circle around the point while missing it.
  If the airline wants to ensure future supply at a given prices they can simply buy futures settled in actual product.
  Hedging against future volatility by agreeing on a deal "now" is the entire point. Sure, sometimes you lose when there's a price drop but the other guy won. At the end of the day everyone benefits from smoothing out the volatility.
  Buying and selling cash settled futures is just how small time buyers and sellers access the market since they can't take delivery of entire train loads of goods but still need to hedge.
  Finance professionals trading them around to wring out an extra percent here and there it beside the point.
  
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  seanhunter 15 hours ago
  
  Hedging can’t be the only point, which is something we have known since the ancient Babylonians invented futures.
  For every person who is trying to hedge future volatility, there has to be a person on the other side of that contract who is speculating on the possibility that the hedge guy is more frightened that they should be.
  You need hedgers and speculators to have a two-way market, and in markets where you have predominantly hedgers they get completely fleeced by the few speculators brave/dumb enough to take the other side of their trades. This is because many markets are structurally unbalanced such that the people who need to hedge long (producers) and people who need to hedge short (consumers) operate on different timeframes etc. So if I’m a farmer growing some crop I might want to sell the 1yr future, but the guy trying to hedge the price for purchase (wholesale grocer or whatever) will be hedging the front future like 1m out. So someone has to carry the risk in the forward curve between 1m and 1 year or noone gets the hedge they need and the market doesn’t work.
  Quite aside from that, there are all sorts of things which are cash-settled because you literally can’t do a physical settlement but people need to hedge (yes and speculate) anyway. Take an index future on an equity index. How are you going to physically settle a future on the SPX or (god forbid) the Russell? The liquidity consequences would be devastating to markets.
  
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  potato3732842 13 hours ago
  
  That's just not the case though.
  Buyers and sellers both want to hedge and they're both happy to give up some potential upside of getting one over on the other guy in exchange for stability.
  As you mentioned, timeframes and volumes often don't match up perfectly. So enter the speculators. They provide a lot of the liquidity. And they get paid for it. Like they make a 1yr bet and 12 1mo counter bets and do that enough that the wins and losses smooth out and they make a few pennies on the dollar.
  The futures market is basically a cyclone of financialization whipping around an eye of "actual business doing actual things" that needs to smooth out volatility (because you can't make a huge investment in a volatile market or you might get screwed into not being able to make payroll some quarter even though what you're up to is solvent any given year).
  You can apply the same model to financial goods (and you often want to because the solvency of all sorts of banking activities is predicated on market conditions the same way that industrial activity is dependent upon commodity prices and you can't have good stuff going tits up because of a bad quarter)
  But at the end of the day you need some core of participants who at the limit are willing to pay to limit/cap/reduce risk and volatility otherwise there's no market because the whole market is bets and counter bets about how that core activity will turn out.
  At the end of the day there is a legitimate business need to hedge against future uncertainty. Everything else in the futures market derives from this, though sometimes the paths are nonsensical.
  
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  kqr 15 hours ago
  
  No, this is a common misconception. If hedging was the point, futures markets would show more evidence of risk aversion than they do. Again, I recommend that Williams' book if you're curious!
  
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- keepamovin 18 hours ago
  
  It would be good if you could do this with cloud capacity.
  
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  formercoder 16 hours ago
  
  Pretty much the Reserved Instance Marketplace
  
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  keepamovin 14 hours ago
  
  Did not know about that! Can you recommend an approach, any cautionary tales? Do clouds beyond AWS have similar?
  
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  kqr 17 hours ago
  
  Doesn't make sense for e.g. compute because compute resources are infinitely perishable. Maybe could work for storage.
  
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- colechristensen 12 hours ago
  
  >Commodity futures are not for the supply of commodities.
  This is a silly statement. Commodity producers absolutely do use futures markets to sell their product.
  >More speculators usually leads to more liquidity and more accurate deals on loans.
  More speculators also leads to more speculation which can lead to anywhere up to a complete disconnect of the price from anything to do with supply or demand.
  Case in point: onion futures are illegal in the US https://en.wikipedia.org/wiki/Onion_Futures_Act
  
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- watwut 16 hours ago
  
  There is no loan necessary in the plane example. Future is an agreement that you will buy/sell a thing for set price in a set date. No one needs to borrow anything for it to work. To manage the repository, the plane company will have contract to by x barrels at 1 of March for some price. That is it, that is what future is - contractual obligation to with a set date.
  Also, while origin stories are nice, most future trades are pure speculations on price. There is no reason to pretend these original stories are how securities are actually used.
  Your story may make a bit more sense with options where one party can choose to exercises their right to sell or buy. Then you can use it to manage actual amounts of commodity. But futures do not carry any such option with it. It is strict agreement with no choices. The plane company can use futures to guarantee certain fuel price in the future, so that some short term market swing wont make fuel too expensive for them.
  
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  kqr 15 hours ago
  
  > There is no loan necessary ...
  That is also not what Williams says. He says a simultaneous long cash--short future position is practically the same as a loan of the corresponding commodity. (With the lending side being short cash--long future.) This activity accounts for many of the patterns we see in futures markets.
  
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  watwut 11 hours ago
  
  That position has zero to do with managing fuel inventory. He was trying to argue this is supposed to help managing inventory in practical world.
  These patterns are about speculation, not about managing inventories.
  
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  seanhunter 14 hours ago
  
  A futures trade always involves variation margin, and if you read a margin agreement you’ll see it is a credit agreement. That’s so people don’t just run away from trades which are underwater and screw the other side over.
  
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  watwut 11 hours ago
  
  That is something you have to do when you do speculative trades. That has zero to do with managing inventory.
  You are not required to take loan to buy futures. You can do so, because then you can bet more then you have. But you dont have to.
  
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Majromax 13 hours ago

> All futures should be settled by the actual commodity!
Why? The legitimate hedging role of futures and options is often financial in nature, even for physically-settled contracts.
Take West Texas Intermediate as an example. That's a physically-settled contract, with delivery in Cushing, Oklahoma.
What if I want to lock in a future price of oil but I'm not in Cushing, Oklahoma? Nobody's going to create a liquid futures market with delivery to my loading dock, but most of the time I can get oil on the spot market from a local supplier that already includes/amortizes the transportation cost.
It's far better for me to use the liquid futures market for hedging and still buy on the spot market, closing out the futures contract before delivery. For me, it's as if the futures market is cash-settled, even with a completely non-speculative transaction.

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miki123211 10 hours ago

I think hedging risks is a better example.
Imagine you're a software company in India, and you want to sign a 5-year contract with an American retailer. The retailer wants to know exactly how many Dollars they'll have to pay you for the software. You want to know exactly how many Rupees you will get to pay your employees.
Without futures, those two goals are incompatible, and the contract does not happen. With futures, the Indian company can decide to accept $1m, and buy a financial instrument that lets them exchange it in 5 years at current Rupee prices. They have to pay somebody for that privilege, but they know exactly how much they're paying, versus having an unbounded risk of currency fluctuations.
You can do the same with oil. Maybe you have no use for crude oil, but you expect your profits to fall as oil prices rise (maybe you're a transportation company locked into a long-term contract). You can hedge that risk by buying futures; if prices rise, you'll lose money on the contract, but you will make it up by selling the (now much more expensive) futures.

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frontfor 19 hours 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.

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hbsbsbsndk 12 hours ago

Contrary to people's expectations, it's not actually possible for "number go up" to continue forever. Privileged people have extracted value from marginalized people, the global south, the environment, and increasingly just domestic wealth inequality. There are fewer and fewer externalities you can profit from.
Not to sound Malthusian, but it was never going to happen that 9 billion people on the planet could live with a North American standard of life, and we stop global warming, and deforestation. It would be a sort of heat death for capitalism with no gradient of inequality left to extract value from.
Financialization is the last gasp attempt to make something from nothing. You're just betting on taking money from another person who is betting on taking money from you. The memeification of retail investing and the entire crypto market are the most naked version where there is simply no relation to any real resources.

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