Futures Markets and Contracts

8/14/2019 Futures Markets and Contracts

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FUTURESMARKETS AND

CONTRACTS


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Futures Contract

- An agreement between twoparties in which one party, thebuyer, agrees to buy from theother party, the seller, an

underlying asset or otherderivative, at a future date at aprice agreed on today


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FUTURES CONTRACTS:Characteristics

PublicTransaction

Standardized

It has secondarymarket

Parties areguaranteed

FuturesExchange

Regulated at thefederal

government level

Daily settlement(marking to

market)

Fungible


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PUBLICSTANDARDIZED

TRANSACTIONS

-public transaction

-futures transaction is not customized

-price is the only term established bythe two parties; the exchange

establishes all other terms

-terms established by the exchangeare standardized


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SPECIFICATIONS OF THE

EXPIRATION

Month

How far the

expirations go out

into the future

Specific day of

expiration


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HOMOGENIZATION AND LIQUIDITY

FORWARD

CONTRACTS

FUTURES

CONTRACTS

Heterogeneous Homogeneous

LiquidIlliquid


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THE CLEARING HOUSE, DAILY

SETTLEMENT AND

PERFORMANCE GUARANTEE

-Futures exchange guarantees toeach party the performance ofthe other party throughclearinghouse

-Daily settlement or marking tomarket


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REGULATION

Commodity Futures TradingCommission (U.S.)

Securities and FuturesAuthority (UK)

National Futures Association(NFA)


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FUTURES TRADING

Floor-based trading or pit trading

Off the floor / electronic / screen-based

trading


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A person who enters into a

futures contract establishes:

Long Position

Short position

Agreements tobuy the

underlying atthe expiration ata price agreedon at the start

Agreements to

sell theunderlying at afuture date at aprice agreed on

at the start


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OFFSETTING

Re-entering themarket and

closing out the

position


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THE CLEARINGHOUSE,

MARGINS AND PRICE LIMITS

MARGIN

Amount ofmoney or

sufficient fundsdeposited by a

trader in amargin account

INITIAL MARGIN

REQUIREMENT

MAINTENANCE

MARGIN

REQUIREMENT

Usually25 to 30

percent

Lowerthan the

stockmarket


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MARGIN IN THE FUTURES

MARKET

-Amount of money that must be putinto an account by a party opening up

a futures position

-More like a down payment for thecommitment to purchase theunderlying at a later date

-Set by the clearinghouses

-Expressed in dollar terms


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SETTLEMENT

PRICE

Official pricedesignated by

the

clearinghouse

Closing price = settlement price?


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MARK -TO MARKET

EXAMPLE

PANEL A. Holder ofLong Position of 10

Contracts


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PANEL B. Holder of Short

Position of 10 Contracts


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VARIATION

MARGIN

Additionalmargin

deposited

-Price change would need to fall for a longposition (or rise for a short position) by thedifference between the initial and maintenancemargin requirement

-In the example, the difference between theinitial and maintenance margin requirements is

$5 - $3 = $2

-The price would need to fall from $100 to $98for a long position (or rise from $100 to $102for a short position) to trigger a margin call


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PRICE LIMITS

Limits on theprice change

from one day tothe next impose

on futurescontracts

LIMIT MOVE

LIMIT UP

The price atwhich

transactionswould be made

exceeds thelimit

If the price isstuck at theupper limit


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LIMIT DOWNIf price is stuck

at the lower limit

LOCKEDLIMIT

Situation wheretransactioncannot take

place


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DAILY

SETTLEMENTPROCEDURE

Collect lossesand distribute

gains


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DELIVERY AND CASH

SETTLEMENT

DELIVERY

Clearinghouseselects a

counterparty to

accept delivery

CASH

SETTLEMENT

Trader would not

need to close outthe position

close to the endof the expiration

day


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CALL FOR DELIVERY

PHYSICAL

DELIVERY

Physicalcommodity

Financial assetBOOK ENTRY


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DISADVANTAGES OF

DELIVERY

Transaction costs of delivery

Variety of features that can complicate

delivery


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DELIVERY

OPTION

The right to

make decisionconcerningaspects of

delivery

EXCHANGE FOR

PHYSICALS(EFP)

Long and shortarrange an

alternativedelivery

procedure


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FUTURES EXCHANGES

- a legal corporate entity whoseshareholders are its members

- determines a number of othercontract characteristics, the contractsize

-determines what hours of the daytrading takes place and at whatphysical location on the exchange thecontract will be traded


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-members own memberships calledseats

- each member acts as either a floortraderor a broker


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FLOOR TRADER

-typically called locals

-Market makers

-Ready to buy and sell byquoting a bid and ask price


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BROKER

- typically called futurescommission merchants

- execute transactions for otherparties off the exchange


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SCALPER

Buy or sellfutures contracts,

holding theposition for only

a brief period oftime

DAY TRADER

Holds a position

open longer butcloses allpositions at theend of the day

POSITION

TRADER

Holds positionsopen overnight


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CLEARINGHOUSE

CLEARING FIRM CLEARING FIRM CLEARING FIRM

CUSTOMERS

CUSTOMERS

CUSTOMERS

CUSTOMERS

Futures Markets and Contracts

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