With Bakkt Futures launch, I see many people here on the forum asking what is a future, or simply getting the concept wrong, or again, confusing concepts and exchanging terms.
I will try in this thread to clarify a few points, trying to make things as simple as possible, and taking an example of real cases, using BAKKT and CME bitcoin futures when possible, or other examples.
FUTURES DEFINITION
Futures are financial contracts obligating the buyer (the seller) to purchase (to sell) an asset (called "underlying asset"), such as a physical commodity or a financial instrument, at a predetermined future date and price.
Let's see an example:
If I buy a BAKKT future at 7,942.5, means that on contract expiry, on Oct, 17th 2019, I have an obligation to buy a single bitcoin from Bakkt Warehouse at the price of USD 7,942.5. The actual delivery of the future will be performed the following day Oct, 18th 2019. I can trade this future until Oct, 16th 2019.
Similarly, if I sell a BAKKT future at 7,942.5, means that on contract expiry, on Oct, 17th 2019, I have an obligation to sell a single bitcoin from Bakkt Warehouse at the price of USD 7,942.5.
The following image details all the relevant dates for a future:
- FTD (First Trade Date): initial date available for trading the future contract.
- LTD (Last Trade Date): final date available for trading the future contract.
- FND (First Notice Day): first date when the exchange can inform the holder of a long future position of the delivery of the underlying asset (Bitcoin in this case), it is the first date also when the exchange can inform the short holder he has to deliver the underlying to the point of delivery.
- LND (Last Notice Date): it is the last date when the exchange can order perform the actions detailed above.
- FDD (First Delivery Date): first date when the exchange can actually transfer to the the long future position the property of the underlying asset at the delivery point (in this case the Bitcoin at the BAKKT Warehouse).
- LDD (Last Delivery Date): similarly it's the last date when the exchange can actually transfer to the long future position the property of the underlying asset at the delivery point (in this case the Bitcoin at the BAKKT Warehouse). Once again in this case FDD and LDD coincide.
- FSD (Final Settlement Date): it's the final date when payments are made between the future position holder and the exchange.
Futures contracts detail the quality and quantity and the point of delivery of the underlying asset; they are necessarily standardized as they are traded on an exchange. It is of an utter importance that the asset physically traded at the end of the future is of a given quantity and quality. It might be easy for a financial instrument while this is a huge constrain for physical commodities. Think of AAPL shares are all equals, while a barrel of oil can be very different regarding many qualities.
For example, the WTI future at the CME details the underlying asset in with the following definition found in the
contract specification:
200101.A. Deliverable Crudes
1. Deliverable Crude Streams
Blends of West Texas Intermediate (“WTI”) type light sweet crude streams are only deliverable if such blends constitute a pipeline's designated "common stream" shipment which meets the grade and quality specifications for domestic crude. Enterprise Products Partners L.P. (including any successor in such capacity, “Enterprise”) and Enbridge Pipeline (Ozark) LLC’s (including any successor in such capacity, “Enbridge”) Common Domestic Sweet (“DSW”) Streams that meet quality specifications in Sections 101.A.2.- 12. of this rule are deliverable as Domestic Crude.
2. Sulfur: 0.42% or less by weight as determined by ASTM Standard D-4294, or its latest revision;
3. Gravity: Not less than 37 degrees American Petroleum Institute (“API”), nor more than 42 degrees API as determined by ASTM Standard D-287, or its latest revision;
4. Viscosity: Maximum 60 Saybolt Universal Seconds at 100 degrees Fahrenheit as measured by ASTM Standard D-445 and as calculated for Saybolt Seconds by ASTM Standard D-2161;
5. Reid vapor pressure: Less than 9.5 pounds per square inch at 100 degrees Fahrenheit, as determined by ASTM Standard D-5191-96, or its latest revision;
6. Basic Sediment, water and other impurities: Less than 1% as determined by ASTM D-96-88 or D-4007, or their latest revisions;
7. Pour Point: Not to exceed 50 degrees Fahrenheit as determined by ASTM Standard D-97;
8. Micro Method Carbon Residue: 2.40% or less by mass; as determined by ASTM Standard D4530-15, or its latest revision;
© Copyright 2009 New York Mercantile Exchange, Inc. All rights reserved. Page 2 of 6
9. Total Acid Number (TAN): 0.28 mg KOH/g or less as determined by the first inflection point; using ASTM Standard D664-11a (2017), or its latest revision;
10. Nickel: 8 parts per million (ppm) or less by mass; as determined by ASTM Standard D5708-15, Test Method B, or its latest revision;
11. Vanadium: 15 ppm or less by mass; as determined by ASTM Standard D5708-15, Test Method B, or its latest revision;
12. High-Temperature Simulated Distillation (HTSD) as determined by ASTM Standard D7169-16, or its latest revision, as follows:
(a) Light Ends <220°F by HTSD: Not more than 19% by mass;
(b) 50% Point by HTSD: 470°F- 570°F;
(c) Vacuum Residuum >1020°F by HTSD: Not more than 16% by mass.
200102. TRADING SPECIFICATIONS
You see that detailing the quality of a barrel of oil is way much more complicated than detailing the underlying asset of the BAKKT future:
1 Bitcoin
Here we have a difference with CME future.
While one future contract in BAKKT controls 1 Bitcoin, 1 future on CME controls 5 bitcoins:
Contract Unit 5 bitcoin, as defined by the CME CF Bitcoin Reference Rate (BRR)
So while BAKKT future has a nominal value of around USD 8,000, CME future has a notional value of 5*USD 8,000 = USD 40,000
Also contract size influences minimum price movement: the lower the contract value, the lower the minimum price movement (tick value):
BAKKT
Minimum Price Fluctuation
$2.50 per bitcoin ($2.50 per contract).
CME:
Minimum Price Fluctuation Outright: 5.00 per bitcoin=$25.00
This means that BAKKT contract can move from 8,000 to 8,002.5, meaning the holder of a contract gains 2.5 USD, while CME future can move from 8,000 to 8,005, meaning the holder of a contract gains 25 USD.
It is not compulsory to actually deliver the underlying assets.
A first differentiation between futures is the one between physically settled versus cash settled:
According to
Wikipedia (minor edits for clarity)
- Physical delivery − the amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. Physical delivery is common with commodities and bonds. In practice, it occurs only on a minority of contracts. [...] The Nymex crude futures contract uses this method of settlement upon expiration.
- Cash settlement − a cash payment is made based on the underlying reference rate [...]. The parties settle by paying/receiving the loss/gain related to the contract in cash when the contract expires.[11] [...]
Here comes the first innovation of BAKKT futures, which are physically settled, an actual bitcoin is delivered to the buyer of the future; CME futures instead are cash settled, meaning at the end of the future the dollar equivalent of a Bitcoin is paid to the holder of the future.
Regarding the point of delivery, WTI is again much more complicated than Bitcoin.
WTI:
Delivery shall be made free-on-board ("F.O.B.") at any pipeline or storage facility in Cushing, Oklahoma with pipeline access to Enterprise, Cushing storage or Enbridge, Cushing storage. Delivery shall be made in accordance with all applicable Federal executive orders and all applicable Federal, State and local laws and regulations.
At buyer's option, delivery shall be made by any of the following methods: (1) by interfacility transfer ("pumpover") into a designated pipeline or storage facility with access to seller's incoming pipeline or storage facility; (2) by in-line (or in-system) transfer, or book-out of title to the buyer; or (3) if the seller agrees to such transfer and if the facility used by the seller allows for such transfer, without physical movement of product, by in-tank transfer of title to the buyer.
BAKKT:
Delivery Locations
Bakkt Warehouse
Pretty simple then. BAKKT is actually providing clients with a warehouse (basically, a wallet) where they can deposit their bitcoin to be traded against their future.
In real markets, the actual delivery rate of the underlying goods specified in futures contracts is very low: only few of the traded futures get ever settled, physically or financially. Most futures positions are actually closed, or exited before the actual expiry of the future, performing an opposite action: buyers (sellers) of the future sell (buy) an equivalent quantity of the same future contract offsetting their position toward the exchange, effectively exiting your position without taking the delivery of the future.
This lead to another concept in future: open interest and volume.
Again from
Wikipedia:
Open interest (also known as open contracts or open commitments) refers to the total number of outstanding derivative contracts that have not been settled (offset by delivery).
For each buyer of a futures contract there must be a seller. From the time the buyer or seller opens the contract until the counter-party closes it, that contract is considered "open".
Volume instead is quite a straightforward
definition:
Volume is the number of shares or contracts traded in a security or an entire market during a given period of time. For every buyer, there is a seller, and each transaction contributes to the count of total volume. That is, when buyers and sellers agree to make a transaction at a certain price, it is considered one transaction. If only five transactions occur in a day, the volume for the day is five
Let's see an example:
- A sells a future to B: Total volume is 1, open interest is 1
- C sells a future to B: Total volume is 2, open interest is 2
- D sells a future to A: Total volume is 3, open interest is 2
In the last trade A closed his position, who was "passed" to D: hence the total positions open on the market is unchanged to 2: B is long 2 contracts, C and D are short 1 each.
- B sells a future to C: Total volume is 4, open interest is 1
- B sells a future to D: Total volume is 5, open interest is 0
After those 5 trades (volume= 5), there is no more open interest, all positions on the future are closed, everyone is flat, no final settlement happens at the exchange.
On BAKKT we get informations on Volumes only, not open interest (UPDATE: Open Interest figures are now available via Bloomberg Terminal see this
update).
On the 25th of September 131 contracts were traded, but we don't know anything on how open interest changed.
On the CME we get
both informations: 
On the 25th of September 5,824 contracts were traded on the September expiry, there are a total of 1172 contracts open, 737 less than yesterday close (actually OI are not updated on real times, so both those figures relate to one day before, but you get the concept). This means there are 737 contract less than previous close “live” on the market, potentially deliverable at future maturity.
FUTURE USES
Futures can be used to hedge or speculate on the price movement of the underlying asset.
For example, a bitcoin sensitive business (think of a miner) could use the future to reduce her profit dependency on bitcoin prices movements, locking in a certain level of price, thus reducing risks, selling an appropriate quantity of bitcoin futures.
In case of bitcoin prices going up, profit on mining would go up, but that would be countered by a loss on the bitcoin future, thus erasing the economic impact of such price movement of the underlying assets.
In the opposite scenario, a decrease of the bitcoin price would translate in less profits coming the mining operations, but the short position of on the future would cause a similar size profit.
In both scenarios then the final profit of the miner, the sum of mining operation plus the profit/loss from the future positions, would be unaffected.
This process is called hedging: the purpose of hedging is not to gain from favorable price movements in the underlying assets, the bitcoin in this example, but prevent losses from unfavorable price movements and maintain a predetermined financial result: the miner actually hedged herself from bitcoin price movements attaining the same level of profitability with any bitcoin price scenario. Of course it forfeited gains in case of bitcoin price increases, but protected herself from a scenario of reduced prices that could potentially end the mining operation in the first place.
The second main use for Future contract is speculation.
To speculate means profiting on the future position from movements in the prices of the underlying asset.
If a market participant wants to speculate on an increase in the price of the underlying asset in the future, he could gain by purchasing a futures contract and selling it later at a higher price on the future market or profiting from the favorable price difference versus the spot market once the future has settled (taking delivering of the underlying asset after the settlement of the future and selling it on the spot market).
The risk is of course is to face a loss in case of an adverse price movement, a slump in prices in this case. If the price ends up being lower than what it was when the future position was opened the holder of a long position will find himself buying the underlying at the set prices at the moment of trade inception, and selling the underlying asset at a lower price on the spot market, thus incurring in a loss.
On the opposite, he who wants to profit from a lower price, should sell the future, effectively gaining from buying at a lower price to settle the future selling it at a previously determined higher price to the holder of the long position of the future.
FUTURE PRICE SLOPE: CONTANGO AND BACKWARDATION
Let’s look at the futures currently quoted at the CME:
According to CME the following Contracts must be Quoted:
| Listed Contracts | Quarterly contracts (Mar, Jun, Sep, Dec) listed for 2 consecutive quarters and the nearest 2 serial months. |
In fact the quoted contracts are the following:
| FUTURE | MONTH | LAST TRADE DATE | PRICE | OPEN INTEREST |
| BTCV9 | Oct-19 | 25/10/2019 | 8275 | 2142 |
| BTCX9 | Nov-19 | 29/11/2019 | 8290 | 248 |
| BTCZ9 | Dec-19 | 27/12/2019 | 8360 | 943 |
| BTCH0 | Mar-20 | 27/03/2020 | 0 | 0 |
September expiry has just expired at the moment of writing so the two main cycles expiries are DEC 19 and MAR 20 (just quoted, not traded yet), while the serial ones are OCT 19 and NOV 19.
We note that the bigger open interest is on the front contract, while the serial contract has little interest, and the last serial contract is too new to have any open interest (it has been quoted only since a few hours).
If we look at the prices we see those are rising: the calendar spread (the difference between prices on different expiries) is positive.
One should think that this is some kind of “market expectations of rising bitcoin prices” between today and December.
Well, this is wrong!
The best expectation for the price in the future is the spot price, as it incorporates all the public information set available to price also future prices. If I had the certainty of a rise in bitcoin price in one year, or if I simply had a rational expectation on this, I could simply buy bitcoin, making the price rise, and hence moving the spot price closer to the future price. This is, with some oversimplification, a non arbitrage conditions linking pricing of a same asset in different times.
The future price should always be something like that:
Future prices = spot price (1+ risk free rate) + cost of carry – convenience yield.
Let’s see what does it mean:
Spot price: as we have seen the best estimate for a future price is the spot price, because all the public informations about the future are already discounted in market price (
semi-strong market efficiency à la
Fama).
Funding Costs: are represented by the parte (1+ risk free rate): buying a bitcoin and trading future require financing the position. Low interest rates globally tended to subdue the importance of this factor, which should be a cost and hence tends to increase the future prices.
Cost of carry: or the cost holding bitcoin until the future maturity, this is what mainly influences the slope of the future prices being upward or downward sloping. Cost of carry is the cost for storing a Bitcoin. It might be low for Bitcoin compared to other future underlying assets (think of storing a bitcoin instead of storing a gold bullion, or a barrel of oil), but alas, insurance costs and storage at an industrial level cannot be neglected. To sum up, if I incur into a cost to store my underlying asset, this mean that the future price I want to sell this asset will be higher than spot, to compensate for that such costs, hence driving future price up.
The convenience yield is the value of having the availability of use of the underlying asset until future maturity. It is particularly relevant for financial asset, representing the coupon or dividend paid from spot date until future maturity. It can be thought like a negative cost of storage, a sort of “income for storage”, or profit coming from holding the asset itself. In case of bitcoin the convenience yield could potentially come from earnt interest coming from lending my Bitcoin to an exchange or a third party (think of BlockFI): If I earn an interest lending my bitcoin to BlockFi I can I will be willing to buy them spot and sell them in the future below current market price, if the difference is more than compensated by interests earned.
The reason why future prices exhibit a positive (or negative) sloping shape has to do with the cost of carry of the position versus the convenience yield: if the convenience yield is lower than cost of carry, think of any physical commodity, then the future curve will exhibit a contango, while if the convenience yield is higher than cost of storage (this is true in many financial asset future) then the future price slope will be characterized by a backwardation.
The shape of the curve can also vary over time: while it is on contango today, it hasn’t always been like this as it was in backwardation at the timing of
CME/CBOE future launch. It’s always worth a think considering which forces are driving the slope of the curve in a sort of “Mixed nature” underlying like bitcoin.
COMMITMENTS OF TRADERS:
Every exchange has a "commitment of traders" report, where you can get insight on the positioning of players on the exchange.
The commitment of traders report for Bitcoin Futures at CME (the only relevant one for the moment) can be found at the following
link and selecting Equity Indexes, then Cryptocurrencies and finally Bitcoin as Underlying:
I strongly recommend you to read the
User Guide detailing all the technicalities of how this chart is made, but here I will tell you the main thing:
of course the total open long positions are equal to short positions, if looking at an aggregate quantities: Open Interest is equal to the sum of Longs (or Shorts) + Spread positions.
This is clearer if we look at a breakdown by table:
of course different type of player have different approach to trading, so knowing if they are long or short can be somewhat useful.
Even more interesting is studying the evolution of long/short balance , Volume and Open Interest: this can give us an hint on how the positioning of players is influencing the price action.
USEFUL LINKS:
Another resource i strongly support is the following this course by CME:
INTRODUCTION TO FUTURES: Definition of a Futures ContractThat is actually a very complete course on futures, providing very useful information on futures definitions, uses, and all the implementation details at CME. Definitely worth a read.
This post is only an initial version and covering only a few topics.
I can go in deeper details or cover additional topics.
For sure a few topics I want to explain in greater details:
Term structure (contango/backwardation)- Margins on the open positions (Initial margins/Variation margins/Marking to Market)
-
Commitments of traders example
I am by the way open to your suggestions to improve the thread. Let me know how to improve this post.
This post is eligible for my project:
I am a strong believer in the utility of local boards.
I am lucky enough to be able to express myself in at least a couple of languages, but I know this is not the case for everyone.
A lot of users post only in the local boards because of a variety of reasons either language or cultural barriers, lack of interest or whatever other reason.
I personally know a lot of very good users (from the italian sections mainly, for obvious reason) who doesn't post in the international sections.
I think all those users they are missing a lot of good contents posted on the international (english) section or on other boards.
If you think you can help here, just visit the thread!
Russian Translation by
FontSeli:
Bce, чтo вы xoтeли бы знaть o фьючepcax нa BTC
