Futures profit and loss

[Benjamin]

Hi,

With reference to the CMP question Ch1, q1.3 (on p.8), could you clarify the part of the response that says that an unlimited loss is matched by an unlimited profit on the underlying?

If you own a physical asset and sell a futures contract, you are agreeing to exchange the physical asset for the price in the contract so if you reach delivery and the price of the underlying is enormous, you lose the difference between the futures price and market value, per the earlier part of the answer. If you choose to close out the position and have to buy contracts at a higher price, you also lose.

So what exactly is matched here?

It doesn't seem possible that a buyer could sustain an unlimited gain but a seller's loss is offset by the underlying as it's zero sum - you either close out and lose cash or you deliver and lose what you would have got for it in the market.

 

[Simon James]

It is a zero-sum game. If the asset is exchanged then the seller's position is "less one asset" and the buyer is "plus one asset". The seller has "lost" the paper gain they could have made on selling the asset on the open market. The buyer can sell the asset on the open market and so has gained an equal amount.