A futures contract is created when there's an increase in open interest, signifying a new agreement between a buyer (going long) and a seller (going short). This doesn't involve issuance by a central authority, but rather arises from the interaction of market participants.
Essentially, unlike stocks or bonds which are issued by companies or governments, futures contracts come into existence through a matching of willing buyers and sellers in the market. Here's a more detailed breakdown:
- No Central Issuance: Futures contracts aren't issued by a single entity. They emerge from the dynamics of the market.
- Increase in Open Interest: The creation of a new futures contract is reflected in an increase in open interest. Open interest represents the total number of outstanding futures contracts on a particular underlying asset.
- Matching Buyer and Seller: A new contract is created when a buyer (who is long, meaning they agree to buy the underlying asset at a future date) is matched with a seller (who is short, meaning they agree to sell the underlying asset at a future date).
- Existing Contracts vs. New Contracts: If a buyer purchases a contract from a seller who is closing out an existing position, open interest remains unchanged. Only when both parties are initiating new positions does the contract count as "new" and increase open interest.
Example:
Imagine a wheat futures contract. If a farmer (seller) wants to lock in a price for their future harvest and a bakery (buyer) wants to secure a price for their wheat supply, they can enter into a futures contract. If both are opening new positions, a new wheat futures contract is created, increasing the overall open interest for that specific contract month.
Key takeaway: The creation of a futures contract is directly tied to the willingness of market participants to take opposing sides of a transaction, creating a new agreement that contributes to the total open interest in the market. It's not a static number; it fluctuates as new contracts are created and existing ones are closed out.
