natsb88 wrote:Jonflyfish wrote:Derivatives are derived from the underlying...Exchanging for physical i.e. taking delivery is certainly an option and you don't know who has what physical supply for delivery. It is not a requirement to file your inventory position if you choose to sell(short) a contract but if assigned at expiration you are required to deliver so it is not knowable.
That bothers me a great deal. Where else, other than the financial markets, can you sign a contract agreeing to deliver a physical commodity, without having any proof that you actually own said physical commodity? I can't get a mortgage without proving there's a house, I can't rent an apartment without a cash deposit, but I can short 5000 ounces of silver without any need to prove I can deliver? Obviously the majority of contracts are settled in cash, and I would suspect the majority of those selling shorts don't have the physical silver. That just seems like a ridiculous system. If you are going to have a derivative commodities market, call it what it is - taking bets on the price of commodities. No delivery option, no delivery requirement. Just bets. This quasi-link between the derivative financials and the physical markets (intentionally, I suppose) leaves a lot of room for funny business. Futures should be fully backed by all players, in which case they would closely follow the physical market but have less influence on the supply and demand characteristics, or be a true derivative and be completely disconnected from the physical market with no options for delivery. This half-assed connection, where you have to posses the silver, but not really, is what allows the financial market to drive the physical market and speculators to play spectacular games while more often than not the true physical producers and consumers, tiny in comparison to the speculators, get the short end of the stick.
When you do get a mortgage, where do the funds from the lending institution come from? In a fractional reserve banking system, aren't you borrowing something that didn't exist until poof!...the funds magically appear against a fraction of what actually existed (a fraction of a promissory note that was also promised to be paid back with another note. Gotta love those FRN's!)
Futures contracts are not an obligation to deliver physical. If you choose to carry your position into expiration (assuming you are allowed by the FCM) you are then agreeing to buy the contract spec or deliver, depending on if you were long or short the contract. Now the FCM, not the trader is obligated to make delivery to the exchange if there is an assignment. This is a risk to the FCM. Given that most are not physical commodity brokers (imagine the infrastructure needed to deliver commodities such as soy beans, silver, ULSD, cotton, live cattle etc at specified delivery points) Given this scenario, nearly all FCM's generally prohibit contracts from going into expiration. And they do not make that a secret. Those very few that do offer delivery often require possession and/or to hold title of deliverable assets before allowing this exposure. Their clients are understandably large commercial operations. Typically, if someone notifies the FCM that says they do not permit delivery, they may make exceptions and make arrangements on a per case basis to arrange to make or take delivery. However, as stated before, the futures market due to basis diffs and logistics is generally a less than attractive portal for procurement. Most all traders use the market as a derivative, even though there is an EFP possibility at expiration. An added note, not all small specs are directional traders. Some are hedging their own physical stack or mining claim etc.
Selling short or buying long, with or without physical ownership does not in any way mean you will somehow have a profitable outcome. Price is price and settlement prices are very real to account balances large and small.
Cheers!
