Both the buyer and the seller create the contract through the exchange. Let's imagine that there is zero open interest currently (as might be the case if you wanted to trade a contract which expires in a year).... You contact the exchange through your broker and bid to buy "1 Jun08 ES @ 1650". At this point, all you have is a "bid". If nobody wants to sell you "1 Jun08 ES @ 1650", there is no contract. However if somebody does sell you 1, then you have a contract... you're long, he's short.
Are you asking about "Open Interest" ? ... here is the open interest in all of the SP500 (big one) futures contracts. http://www2.barchart.com/dfutpage.asp?sym=SP&code=BSTK ... as you can see, there is only 1 contract of "open interest" for the Sep 2008 SP500. I would assume, one "market maker" in the SP pit, took the "other side" of a retail trade here. Creating an open interest of 1. I would also assume that the Market Maker got a very favorable price due to the lack of liquidity of this futures contract. For physical commodities ... You may also want to read about how the Hunt brothers tried to corner the market on Silver. In this case, I believe there were more outstanding futures contracts than actual, deliverable silver. Their idea was to buy up as much real physically deliverable silver as possible and squeeze the holders of the futures contracts. The Fed stepped in and intervened and changed the rules of the futures exchanges to prevent it from happening again
... a starting point on the Hunt brother's siliver episode http://en.wikipedia.org/wiki/Silver_Thursday
Think about 10 bottles of milk. Although the supply is limited, you can still have literally millions of people placing bets on the future price of milk. If the price per bottle goes up by a dollar, this dollar is transfered from the wallet of the seller of the future's contract to the wallet of the buyer of the futures contract. The milk actually stays where it was. In the futures market, it's called cash settlement, and the number of open contracts is called open interest. Now you can see that the number of contracts is not really indicative of the supply and demand for the underlying product. Instead, it indicates how many people are interested in placing bets on the price direction, and how much money they are willing to bet.
but a lot of people buy the "market price"... in stocks... say you have stock XYZ that has 3 shares total at $10 each... because there are only 3 shares.... it would look something like this... first bidder will get share number 1 at $10 second bidder will get share number 2 at $10 third bidder will get share number 3 at $10 but since there is no share number 4... the next round would be... share number 1 will be worth $11 and then share number 2 will be worth $11 then share number 3 will be worth $11 then so on... because there is only a limit of 3 shares.... but in futures, if there are unlimited contracts and a lot of people just hit the "buy market" button... it must mean that the market maker tends to control the bid and ask price pretty much most of time unless people set buy and sell limits... someone please correct what I'm not seeing... I understand that in stocks there is a market maker just like there is in futures, but I can see how the market maker has no choice but to raise prices when there is a limited supply of stocks... but if there isn't a limited supply of contracts and everyone just hit's "buy market"... how is the price determined ? (or the bid and ask)
There is no market maker... prices are set by individuals.... could be retail, pit locals, or institutions. When someone "buys @ the market" he's actually buying the currently lowest offered price(s), as best can be filled by his broker.
I thought I read there was a market maker in futures in any case, how are these price(s) determined (bid and ask price), when there are unlimited amount of contracts that can be created and both sides hit the the buy/sell market price button?
In a strict sense, a market maker is someone who is obligated to show both the bid and the ask, and to honor both sides of the market. By that definition, there are no market makers in the S&P E-mini futures (which you are discussing). Instead, there is a computer system known as Globex, where the orders come in eletronically and the matching takes place. Regarding the price setting, the number of contracts has very little to do with the price, as I explained in the previous post. The reason the abnormalities (such as the one that you are referring to) almost never hapen is because of the arbitrage, which was mentioned a number of times. You may want to pick up a book on the topic (such as Trading and Exchanges), but here is a gist of it: if the bottle of milk costs $1, and someone is betting that it will be $2 tomorrow, I could simply buy milk and sell your $2 bet. No matter what happens to price of milk, I'll make $1, risk free. Since everyone wants to make money risk free, these opportunities are taken very early, at very low discrepancies. In effect, they don't exist, unless you want to compete with the arbitragers for fractions of a penny.