When You Invest In Futures...

[Jinx]

I don't understand this concept of investing in futures. For example, I hear oil R&D is highly funded by investment in futures. As I understand it, investors hope that such an investment will pay-off big, but is there some kind of time window which defines "the future"? For example, should a big payoff come 2 years from now, can the company say "oh, sorry...you only bought enough of the future to cover one year, so you lose out on the profits." Does it work like this?

Or, is it as long as your invested, you'll share in the profits? How does this work?
When do you know you've reached "the future"? - Jinx

[Captain Lance Murdoch]

A futures contract covers a set point in time. For instance you could buy a March contract for hard red spring wheat today that would be a speculation on the price of said commodity in March of 2005.

[Chairman Pow]

Originally Posted by Jinx

I don't understand this concept of investing in futures. For example, I hear oil R&D is highly funded by investment in futures. As I understand it, investors hope that such an investment will pay-off big, but is there some kind of time window which defines "the future"? For example, should a big payoff come 2 years from now, can the company say "oh, sorry...you only bought enough of the future to cover one year, so you lose out on the profits." Does it work like this?

Or, is it as long as your invested, you'll share in the profits? How does this work?
When do you know you've reached "the future"? - Jinx

A futures contract is an agreement between a buyer and seller to exchange a fixed amount of goods at a date in the future for an agreed upon price. The contract specifies what is to be traded, the quality of the commodity and the price at which it will be traded for.

Using oil from your example: Light Sweet Crude Oil is traded at the New York Mercantile Exchange. Here are the specifications for a contract. You can see that it is standardized.

If I chose to buy a contract of oil, I would have to determine what month I want to take delivery in (i.e. when the contract expires and I have to pay up). There are various factors that will affect my choice (for example, if I need the oil itself or if I just want to speculate on the price).

I, as a buyer, don't owe the seller any money until I actually take delivery on the oil (that's a bit of a simplification, but generally true). Likewise, the seller doesn't owe me the oil until the agreed-upon date.

The benefits to this for both the buyer and seller are: 1) I, as a buyer, can choose the price I'm willing to pay for the oil and budget accordingly (again, a simplification as the market will dictate what the "fair" price is and I can choose to buy it or not) and 2) the seller can determine what price he wants to sell for and help determine his cash flow (again, simplified).

If I am speculating, I have no interest in actually taking delivery on the oil (if I'm a buyer or delivering it if I am the seller), but I want to take advantage of the price difference between what I believe it to be worth (rather, what I believe it will be worth) and what the price currently is. To end my obligation of having to purchase or deliver the oil, I merely need to sell it to someone else or find someone else to buy it (preferably at a profit to where I entered the contract from). I transfer the contract to them and my obligation is done. I then collect any profits or pay any losses and go on with my life.

That's pretty much the basics of the mechanics of futures with regard to your question (and a lot more besides).

[KidCharlemagne]

The vehicles the OP is speaking of are not really futures. They are just agreements to pay a third party a portion of the find in either cash or oil. It's akin to a movie star taking points on his movie. If an oil field developer believe there is a good cache of oil but doesn't have the money to drill, he borrows from a third party guaranteeing them either a percentage of the profits in oil or cash.