I would like to know if my understanding of the futures market is correct. Firstly, only producers of commodities can sell short and can buy a short position; while anyone can buy long. Secondly, one of the parties have to pay a margin for the loss they have suffered daily to the risk of losing their position, and a margin deposit initially as well as a certain percentage of contract value. Thirdly, transactions have to be made with the commodity that was traded or fiat currency. Fourthly, if either the suppliers or the buyers default massively unable to pay in the commodity that was traded or in fiat currency, the future market will likely crash, which is the reason why there was concern over the COMEX in recent weeks. Correct me if I am wrong, please.
First of all, futures is not the same thing as short selling. You seem to think they’re equivalent. Futures are contracts where the delivery date (which is in the future) and price is previously agreed upon. It’s also possible to have futures on non-commodities, like stock indices (although they’re more like a CFD in this case, as far as I can see). On the other hand, short selling occurs when one sells borrowed commodities (whatever they may be), hoping for the price to fall and buy them back at a lower price to repay the debt. Shorting can occur on any market and involving any commodities: spot (regular secondary market), futures or other derivatives. So futures doesn’t imply shorting and neither the other way around.
Secondly, everyone can sell short given they meet some minimum requirements (in order to borrow), not only the producers.
Note that unlike forwards, futures are updated daily, not only at the delivery date, so the risk is lower for the parties involved.
But dont futures contracts imply that there is someone who is selling short and someone who is buying long?
Also, if the commodities are borrowed, and therefore imply that the sellers have them at hand, in short selling, how can mining companies can actually sell commodities they don’t actually have, wouldn’t it be a fraud?
No. Long and short simply tell whether you own what you sell. In the futures market, you can exchange money for gold for example, but both sides usually go long. Same thing as in the spot market.
You first borrow it and then sell it. If the market evolves as you expected, you’ll buy it back at a lower price. Then you repay the quantity that you borrowed and keep the difference. If on the other hand the prices go up, you’ll have to support the losses from your own pocket.
The winnings are limited (price goes to 0), the losses aren’t (price goes to infinity). But generally this type of leveraged transactions come with a thing called a “stop-loss order”, which one can use to limit losses. Contrast that with long positions, where winnings are unlimited and losses are limited.
To be a little more clear, in futures market, when one buys/sells long a contract, he buys/sells the obligation to fulfill the transaction on both his part and the counterparty’s part. He could also short sell contracts, by borrowing futures from others. Remember, all the markets we’re talking about are secondary markets.