Comment by ahazred8ta

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.

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?

> 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?

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.

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.

> 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.

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.

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.

That writeup seems exaggerated. When I read the story, it was a newbie at a Bloomberg Terminal who pressed the wrong button.

This is like a friendlier version of r/wsb’s stories.