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• Futures Contract
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Futures contract
In finance, a futures contract (more
colloquially, futures) is a standardized
contract between two parties to buy or
sell a specified asset of standardized
quantity and quality for a price agreed
upon today (the futures price or strike
price) with delivery and payment
occurring at a specified future date,
the delivery date
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Futures contract
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In many cases, the underlying asset to
a futures contract may not be
traditional commodities at all – that
is, for financial futures the underlying
item can be any financial instrument
(also including currency, bonds, and
stocks); they can be also based on
intangible assets or referenced items,
such as stock indexes and interest
rates.
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Futures contract
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While the futures contract specifies a
trade taking place in the future, the
purpose of the futures exchange
institution is to act as intermediary
and minimize the risk of default by
either party
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Futures contract
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A closely related contract is a forward
contract. A forward is like a futures in
that it specifies the exchange of goods
for a specified price at a specified
future date. However, a forward is not
traded on an exchange and thus does
not have the interim partial payments
due to marking to market. Nor is the
contract standardized, as on the
exchange.
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Futures contract
To exit the commitment prior to the
settlement date, the holder of a futures
position can close out its contract
obligations by taking the opposite position
on another futures contract on the same
asset and settlement date
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Futures contract - Origin
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The first futures exchange market was
the Dōjima Rice Exchange in Japan in
the 1730s, to meet the needs of samurai
who—being paid in rice, and after a
series of bad harvests—needed a
stable conversion to coin.
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Futures contract - Origin
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The Chicago Board of Trade (CBOT)
listed the first ever standardized
'exchange traded' forward contracts in
1864, which were called futures
contracts
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Futures contract - Standardization
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Futures contracts ensure their liquidity by being
highly standardized, usually by specifying:
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Futures contract - Standardization
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The underlying asset or instrument.
This could be anything from a barrel
of crude oil to a short term interest
rate.
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Futures contract - Standardization
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The amount and units of the underlying
asset per contract. This can be the
notional amount of bonds, a fixed
number of barrels of oil, units of
foreign currency, the notional amount
of the deposit over which the short
term interest rate is traded, etc.
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Futures contract - Standardization
The currency in
which the futures
contract is quoted.
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Futures contract - Standardization
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The grade of the deliverable. In the case of
bonds, this specifies which bonds can be
delivered. In the case of physical
commodities, this specifies not only the
quality of the underlying goods but also the
manner and location of delivery. For example,
the NYMEX Light Sweet Crude Oil contract
specifies the acceptable sulphur content and
API specific gravity, as well as the pricing
point—the location where delivery must be
made.
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Futures contract - Standardization
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Other details such as the commodity tick, the
minimum permissible price fluctuation.
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Futures contract - Margin
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To minimize credit risk to the exchange,
traders must post a margin or a
performance bond, typically 5%-15% of
the contract's value.
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Futures contract - Margin
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To minimize counterparty risk to traders,
trades executed on regulated futures
exchanges are guaranteed by a clearing
house. The clearing house becomes the
buyer to each seller, and the seller to each
Buyer, so that in the event of a
counterparty default the clearer assumes
the risk of loss. This enables traders to
transact without performing due diligence
on their counterparty.
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Futures contract - Margin
Margin requirements are waived or
reduced in some cases for hedgers who
have physical ownership of the covered
commodity or spread traders who have
offsetting contracts balancing the position.
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Futures contract - Margin
Clearing margin are financial
safeguards to ensure that companies
or corporations perform on their
customers' open futures and options
contracts. Clearing margins are
distinct from customer margins that
individual buyers and sellers of
futures and options contracts are
required to deposit with brokers.
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Futures contract - Margin
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Customer margin Within the futures industry,
financial guarantees required of both buyers
and sellers of futures contracts and sellers of
options contracts to ensure fulfillment of
contract obligations. Futures Commission
Merchants are responsible for overseeing
customer margin accounts. Margins are
determined on the basis of market risk and
contract value. Also referred to as
performance bond margin.
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Futures contract - Margin
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Initial margin is the equity required to
initiate a futures position. This is a
type of performance bond. The
maximum exposure is not limited to
the amount of the initial margin,
however the initial margin
requirement is calculated based on
the maximum estimated change in
contract value within a trading day.
Initial margin is set by the exchange.
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Futures contract - Margin
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If a position involves an exchange-traded
product, the amount or percentage of
initial margin is set by the exchange
concerned.
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Futures contract - Margin
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In case of loss or if the value of the initial
margin is being eroded, the broker will
make a margin call in order to restore the
amount of initial margin available. Often
referred to as “variation margin”, margin
called for this reason is usually done on a
daily basis, however, in times of high
volatility a broker can make a margin call
or calls intra-day.
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Futures contract - Margin
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Calls for margin are usually expected to be
paid and received on the same day. If not,
the broker has the right to close sufficient
positions to meet the amount called by
way of margin. After the position is closedout the client is liable for any resulting
deficit in the client’s account.
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Futures contract - Margin
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Some U.S. exchanges also use the term
“maintenance margin”, which in
effect defines by how much the value
of the initial margin can reduce before
a margin call is made. However, most
non-US brokers only use the term
“initial margin” and “variation
margin”.
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Futures contract - Margin
The Initial Margin requirement is
established by the Futures exchange,
in contrast to other securities' Initial
Margin (which is set by the Federal
Reserve in the U.S. Markets).
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Futures contract - Margin
A futures account is marked to market
daily. If the margin drops below the margin
maintenance requirement established by
the exchange listing the futures, a margin
call will be issued to bring the account
back up to the required level.
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Futures contract - Margin
Maintenance margin A set minimum
margin per outstanding futures contract
that a customer must maintain in their
margin account.
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Futures contract - Margin
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Margin-equity ratio is a term used by
speculators, representing the amount
of their trading capital that is being
held as margin at any particular time
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Futures contract - Margin
Performance bond margin The
amount of money deposited by both a
buyer and seller of a futures contract
or an options seller to ensure
performance of the term of the
contract. Margin in commodities is
not a payment of equity or down
payment on the commodity itself, but
rather it is a security deposit.
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Futures contract - Margin
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Return on margin (ROM) is often used
to judge performance because it
represents the gain or loss compared
to the exchange’s perceived risk as
reflected in required margin. ROM
may be calculated (realized return) /
(initial margin). The Annualized ROM
is equal to
(ROM+1)(year/trade_duration)-1. For
example if a trader earns 10% on
margin in two months, that would be
about 77% annualized.
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Futures contract - Settlement - physical versus cash-settled futures
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Settlement is the act of consummating
the contract, and can be done in one of
two ways, as specified per type of
futures contract:
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Futures contract - Settlement - physical versus cash-settled futures
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The Nymex crude futures contract uses this method
of settlement upon expiration
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Futures contract - Settlement - physical versus cash-settled futures
how would one deliver an index? A
futures contract might also opt to
settle against an index based on trade
in a related spot market
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Futures contract - Settlement - physical versus cash-settled futures
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On this day the t+1 futures
contract becomes the t
futures contract
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Futures contract - Pricing
In this scenario there is only one force
setting the price, which is simple supply
and demand for the asset in the future, as
expressed by supply and demand for the
futures contract.
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Futures contract - Arbitrage arguments
Arbitrage arguments ("Rational
pricing") apply when the deliverable
asset exists in plentiful supply, or may
be freely created
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Futures contract - Arbitrage arguments
Thus, assuming constant rates, for a
simple, non-dividend paying asset, the
value of the future/forward price, F(t,T),
will be found by compounding the
present value S(t) at time t to maturity T
by the rate of risk-free return r.
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Futures contract - Arbitrage arguments
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In a perfect market the relationship
between futures and spot prices
depends only on the above variables;
in practice there are various market
imperfections (transaction costs,
differential borrowing and lending
rates, restrictions on short selling)
that prevent complete arbitrage. Thus,
the futures price in fact varies within
arbitrage boundaries around the
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Futures contract - Pricing via expectation
When the deliverable commodity is
not in plentiful supply (or when it does
not yet exist) rational pricing cannot
be applied, as the arbitrage
mechanism is not applicable. Here the
price of the futures is determined by
today's supply and demand for the
underlying asset in the futures.
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Futures contract - Pricing via expectation
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In a deep and liquid market, supply
and demand would be expected to
balance out at a price which
represents an unbiased expectation of
the future price of the actual asset and
so be given by the simple
relationship.
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Futures contract - Pricing via expectation
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By contrast, in a shallow and illiquid
market, or in a market in which large
quantities of the deliverable asset
have been deliberately withheld from
market participants (an illegal action
known as cornering the market), the
market clearing price for the futures
may still represent the balance
between supply and demand but the
relationship between this price and
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Futures contract - Relationship between arbitrage arguments and expectation
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The expectation based relationship will
also hold in a no-arbitrage setting when
we take expectations with respect to the
risk-neutral probability. In other words: a
futures price is martingale with respect to
the risk-neutral probability. With this
pricing rule, a speculator is expected to
break even when the futures market fairly
prices the deliverable commodity.
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Futures contract - Contango and backwardation
The situation where the price of a
commodity for future delivery is higher
than the spot price, or where a far future
delivery price is higher than a nearer
future delivery, is known as contango. The
reverse, where the price of a commodity
for future delivery is lower than the spot
price, or where a far future delivery price is
lower than a nearer future delivery, is
known as backwardation.
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Futures contract - Futures contracts and exchanges
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There are many different kinds of futures
contracts, reflecting the many different
kinds of "tradable" assets about which the
contract may be based such as
commodities, securities (such as singlestock futures), currencies or intangibles
such as interest rates and indexes. For
information on futures markets in specific
underlying commodity markets, follow the
links. For a list of tradable commodities
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Futures contract - Futures contracts and exchanges
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These forward contracts were private
contracts between buyers and sellers
and became the forerunner to today's
exchange-traded futures contracts
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Futures contract - Futures contracts and exchanges
Contracts on financial instruments
were introduced in the 1970s by the
Chicago Mercantile Exchange (CME)
and these instruments became hugely
successful and quickly overtook
commodities futures in terms of trading
volume and global accessibility to the
markets
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Futures contract - Futures contracts and exchanges
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CME Group (formerly CBOT and CME) -Currencies, Various Interest Rate
derivatives (including US Bonds);
Agricultural (Corn, Soybeans, Soy
Products, Wheat, Pork, Cattle, Butter,
Milk); Index (Dow Jones Industrial
Average); Metals (Gold, Silver), Index
(NASDAQ, S&P, etc.)
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Futures contract - Futures contracts and exchanges
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IntercontinentalExchange (ICE Futures
Europe) - formerly the International
Petroleum Exchange trades energy
including crude oil, heating oil, gas oil
(diesel), refined petroleum products,
electric power, coal, natural gas, and
emissions
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Futures contract - Futures contracts and exchanges
NYSE Euronext - which absorbed
Euronext into which London
International Financial Futures and
Options Exchange or LIFFE
(pronounced 'LIFE') was merged.
(LIFFE had taken over London
Commodities Exchange ("LCE") in
1996)- softs: grains and meats.
Inactive market in Baltic Exchange
shipping. Index futures include
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Futures contract - Futures contracts and exchanges
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South African Futures
Exchange - SAFEX
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Futures contract - Futures contracts and exchanges
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Tokyo Stock Exchange TSE
(JGB Futures, TOPIX
Futures)
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Futures contract - Futures contracts and exchanges
Tokyo Financial Exchange - TFX (Euroyen Futures, OverNight CallRate
Futures, SpotNext RepoRate Futures)
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Futures contract - Futures contracts and exchanges
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Osaka Securities Exchange
OSE (Nikkei Futures, RNP
Futures)
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Futures contract - Futures contracts and exchanges
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London Metal Exchange - metals: copper,
aluminium, lead, zinc, nickel, tin and steel
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Futures contract - Futures contracts and exchanges
IntercontinentalExchange (ICE
Futures U.S.) - formerly New York
Board of Trade - softs: cocoa, coffee,
cotton, orange juice, sugar
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Futures contract - Futures contracts and exchanges
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New York Mercantile Exchange CME
Group- energy and metals: crude oil,
gasoline, heating oil, natural gas, coal,
propane, gold, silver, platinum, copper,
aluminum and palladium
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Futures contract - Futures contracts and exchanges
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ROFEX - Rosario (Argentina)
Futures Exchange
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Futures contract - Codes
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Most Futures contracts codes are five
characters. The first two characters
identify the contract type, the third
character identifies the month and the
last two characters identify the year.
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Futures contract - Codes
Third (month)
futures contract
codes are
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Futures contract - Codes
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Example: CLX14 is a Crude Oil
(CL), November (X) 2014 (14)
contract.
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Futures contract - Who trades futures?
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In other words, the investor is seeking
exposure to the asset in a long futures or
the opposite effect via a short futures
contract.
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Futures contract - Hedgers
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Hedgers typically include producers and
consumers of a commodity or the owner of
an asset or assets subject to certain
influences such as an interest rate.
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Futures contract - Hedgers
For example, in traditional commodity
markets, farmers often sell futures
contracts for the crops and livestock they
produce to guarantee a certain price,
making it easier for them to plan
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Futures contract - Hedgers
Those that buy or sell commodity
futures need to be careful. If a company
buys contracts hedging against price
increases, but in fact the market price
of the commodity is substantially lower
at time of delivery, they could find
themselves disastrously noncompetitive (for example see: VeraSun
Energy).
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Futures contract - Speculators
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Speculators typically fall into three
categories: position traders, day
traders, and swing traders (swing
trading), though many hybrid types
and unique styles exist. With many
investors pouring into the futures
markets in recent years controversy
has risen about whether speculators
are responsible for increased
volatility in commodities like oil, and
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Futures contract - Speculators
An example that has both hedge and
speculative notions involves a mutual fund
or separately managed account whose
investment objective is to track the
performance of a stock index such as the
S&P 500 stock index
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Futures contract - Speculators
The social utility of futures markets is
considered to be mainly in the transfer of
risk, and increased liquidity between
traders with different risk and time
preferences, from a hedger to a
speculator, for example.
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Futures contract - Options on futures
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A put is the option to sell a futures contract, and
a call is the option to buy a futures contract
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Futures contract - Options on futures
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Investors can either take on the role of option
seller/option writer or the option buyer
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Futures contract - Futures contract regulations
All futures transactions in the United
States are regulated by the Commodity
Futures Trading Commission (CFTC), an
independent agency of the United States
government. The Commission has the
right to hand out fines and other
punishments for an individual or company
who breaks any rules. Although by law the
commission regulates all transactions,
each exchange can have its own rule, and
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Futures contract - Futures contract regulations
The CFTC publishes weekly reports
containing details of the open interest of
market participants for each marketsegment that has more than 20
participants. These reports are released
every Friday (including data from the
previous Tuesday) and contain data on
open interest split by reportable and nonreportable open interest as well as
commercial and non-commercial open
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Futures contract - Definition of futures contract
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Following Björk we give a definition of
a futures contract. We describe a
futures contract with delivery of item J
at the time T:
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Futures contract - Definition of futures contract
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There exists in the market a quoted price
F(t,T), which is known as the futures price
at time t for delivery of J at time T.
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Futures contract - Definition of futures contract
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The price of entering a
futures contract is
equal to zero.
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Futures contract - Definition of futures contract
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During any time interval , the holder
receives the amount . (this reflects
instantaneous marking to market)
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Futures contract - Definition of futures contract
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At time T, the holder pays F(T,T) and is
entitled to receive J. Note that F(T,T)
should be the spot price of J at time T.
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Futures contract - Nonconvergence
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Therefore, it's impossible for almost any
individual producer to 'hedge' efficiently
when relying on the final settlement of a
futures contract for SRW
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Futures contract - Nonconvergence
It follows that the function of price
discovery, the ability of the markets to
discern the appropriate value of a
commodity reflecting current
conditions, is degraded in relation to
the discrepancy in price and the
inability of producers to enforce
contracts with the commodities they
represent.
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Futures contract - Futures versus forwards
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While futures and forward contracts
are both contracts to deliver an asset
on a future date at a prearranged
price, they are different in two main
respects:
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Futures contract - Futures versus forwards
Futures are exchangetraded, while forwards are
traded over-the-counter.
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Futures contract - Futures versus forwards
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Thus futures are standardized and face
an exchange, while forwards are
customized and face a non-exchange
counterparty.
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Futures contract - Futures versus forwards
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Futures are margined, while
forwards are not.
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Futures contract - Futures versus forwards
The Futures Industry Association (FIA)
estimates that 6.97 billion futures contracts
were traded in 2007, an increase of nearly
32% over the 2006 figure.
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Futures contract - Exchange versus OTC
Futures are always traded on an
exchange, whereas forwards always trade
over-the-counter, or can simply be a
signed contract between two parties.
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Futures contract - Exchange versus OTC
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Futures are highly standardized, being
exchange-traded, whereas forwards can
be unique, being over-the-counter.
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Futures contract - Exchange versus OTC
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In the case of physical delivery, the
forward contract specifies to whom to
make the delivery. The counterparty
for delivery on a futures contract is
chosen by the clearing house.
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Futures contract - Margining
Futures are margined daily to the daily
spot price of a forward with the same
agreed-upon delivery price and underlying
asset (based on mark to market).
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Futures contract - Margining
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Forwards do not have a standard. They
may transact only on the settlement date.
More typical would be for the parties to
agree to true up, for example, every
quarter. The fact that forwards are not
margined daily means that, due to
movements in the price of the underlying
asset, a large differential can build up
between the forward's delivery price and
the settlement price, and in any event, an
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Futures contract - Margining
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Again, this differs from futures which
get 'trued-up' typically daily by a
comparison of the market value of the
future to the collateral securing the
contract to keep it in line with the
brokerage margin requirements. This
true-ing up occurs by the "loss" party
providing additional collateral; so if the
buyer of the contract incurs a drop in
value, the shortfall or variation margin
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Futures contract - Margining
In a forward though, the spread in
exchange rates is not trued up
regularly but, rather, it builds up as
unrealized gain (loss) depending on
which side of the trade being
discussed. This means that entire
unrealized gain (loss) becomes realized
at the time of delivery (or as what
typically occurs, the time the contract
is closed prior to expiration) 1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
1
The result is that forwards have higher
credit risk than futures, and that
funding is charged differently.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
In most cases involving institutional
investors, the daily variation margin
settlement guidelines for futures call for
actual money movement only above some
insignificant amount to avoid wiring back
and forth small sums of cash. The
threshold amount for daily futures variation
margin for institutional investors is often
$1,000.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
1
The situation for forwards, however,
where no daily true-up takes place in
turn creates credit risk for forwards,
but not so much for futures. Simply
put, the risk of a forward contract is
that the supplier will be unable to
deliver the referenced asset, or that
the buyer will be unable to pay for it
on the delivery date or the date at
which the opening party closes the
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
1
The margining of futures eliminates much
of this credit risk by forcing the holders to
update daily to the price of an equivalent
forward purchased that day. This means
that there will usually be very little
additional money due on the final day to
settle the futures contract: only the final
day's gain or loss, not the gain or loss over
the life of the contract.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
1
In addition, the daily futures-settlement
failure risk is borne by an exchange,
rather than an individual party, further
limiting credit risk in futures.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
1
On day 51, that futures
contract costs $90
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
A forward-holder, however, may pay
nothing until settlement on the final day,
potentially building up a large balance; this
may be reflected in the mark by an
allowance for credit risk
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
assets the gain or loss accrues over
the holding period; for a futures this
gain or loss is realized daily, while for a
forward contract the gain or loss
remains unrealized until expiry.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
1
Note that, due to the path dependence
of funding, a futures contract is not,
strictly speaking, a European-style
derivative: the total gain or loss of the
trade depends not only on the value of
the underlying asset at expiry, but
also on the path of prices on the way.
This difference is generally quite
small though.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
With an exchange-traded future, the
clearing house interposes itself on every
trade. Thus there is no risk of counterparty
default. The only risk is that the clearing
house defaults (e.g. become bankrupt),
which is considered very unlikely.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Further reading
1
The National Futures Association
(2006). An Educational Guide to
Trading Futures and Options on
Futures. Chicago, Illinois.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Notes
Jump up ^ Schaede, Ulrike (September
1989). "Forwards and futures in tokugawaperiod Japan:A new perspective on the
Djima rice market". Journal of Banking &
Finance 13 (4–5): 487–513.
doi:10.1016/0378-4266(89)90028-9
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Notes
Jump up ^ "timeline-ofachievements". CME Group.
Retrieved August 5, 2010.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Notes
1
Jump up ^ Inter-Ministerial task force
(chaired by Wajahat Habibullah) (May
2003). "Convergence of Securities and
Commodity Markets report". Forward
Markets Commission (India).
Retrieved August 5, 2010.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Notes
1
Jump up ^ Cash settlement
on Wikinvest
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Notes
1
Jump up ^ Dreibus, Tony C. Commodity
Bubbles Caused by Speculators Need
Intervention, UN Agency Says,
Bloomberg, June 5, 2011. Accessed
July 2, 2011
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Notes
1
Jump up ^ CME Group. "CME Options on
Futures: The Basics". Retrieved 8 February
2011.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Notes
Jump up ^ Björk: Arbitrage theory in
continuous time, Cambridge university press,
2004
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Notes
Jump up ^ Henriques, D Mysterious
discrepancies in grain prices baffle
experts, International Herald Tribune,
March 23, 2008. Accessed April 12, 2008
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Commodity market - Futures contract
Futures contract|Futures contracts
are standardized forward contracts
that are transacted through an
exchange. In futures contracts the
buyer and the seller stipulate product,
grade, quantity and location and
leaving price as the only
variable.Garner, Carley. A Trader's
First Book on Commodities. (New
Jersey: FT Press, 2010): pg 19.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Commodity market - Futures contract
Agricultural futures contracts are the
oldest, in use in the United States for more
than 170 years.Futures Trading Act of
1921, Declared unconstitutional in Hill v
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Dow Jones Industrial Average - Futures contracts
1
In the derivatives market, the CME Group through
its subsidiaries the Chicago Mercantile Exchange
(CME) and the Chicago Board of Trade (CBOT),
issues Futures Contracts; including the
[http://www.cmegroup.com/trading/equity-index/usindex/e-mini-dow.html E-mini Dow ($5) Futures
(YM)], the
[http://www.cmegroup.com/trading/equity-index/usindex/dow.html DJIA ($10) Futures (DJ)] and the
[http://www.cmegroup.com/trading/equity-index/usindex/big-dow-djia.html Big Dow DJIA ($25)
Futures (DD)] which track the average and trade
on their exchange floors respectively
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Futures contract
In finance, a 'futures contract' (more
colloquially, 'futures') is a standardized
contract between two parties to buy or sell
a specified asset of standardized quantity
and quality for a price agreed upon today
(the futures price) with delivery and
payment occurring at a specified future
date, the delivery date
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract
Thus the exchange requires both
parties to put up an initial amount of
cash (performance bond), the Futures
contract#Margin|margin
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract
To exit the commitment prior to the
settlement date, the holder of a futures
position (finance)|position can close
out its contract obligations by taking
the opposite position on another
futures contract on the same asset and
settlement date
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Origin
1
The Chicago Board of Trade (CBOT)
listed the first ever standardized
'exchange traded' forward contracts in
1864, which were called futures
contracts
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margin
1
To minimize credit risk to the exchange,
traders must post a Margin
(finance)|margin or a performance
bond, typically 5%-15% of the
contract's value.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margin
Margin requirements are waived or
reduced in some cases for Hedge
(finance)|hedgers who have physical
ownership of the covered commodity or
spread traders who have offsetting
contracts balancing the position.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margin
1
'Clearing margin' are financial safeguards
to ensure that companies or corporations
perform on their customers' open futures
and options contracts. Clearing margins
are distinct from customer margins that
individual buyers and sellers of futures and
options contracts are required to deposit
with brokers.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margin
'Customer margin' Within the futures
industry, financial guarantees required of
both buyers and sellers of futures
contracts and sellers of options contracts
to ensure fulfillment of contract obligations.
Futures Commission Merchants are
responsible for overseeing customer
margin accounts. Margins are determined
on the basis of market risk and contract
value. Also referred to as performance
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margin
'Initial margin' is the equity required to
initiate a futures position. This is a type of
performance bond. The maximum
exposure is not limited to the amount of
the initial margin, however the initial
margin requirement is calculated based on
the maximum estimated change in
contract value within a trading day. Initial
margin is set by the exchange.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margin
1
'Maintenance margin' A set minimum
margin per outstanding futures contract
that a customer must maintain in their
margin account.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margin
1
'Margin-equity ratio' is a term used by
speculators, representing the amount
of their trading capital that is being
held as margin at any particular time
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margin
1
'Performance bond margin' The amount
of money deposited by both a buyer
and seller of a futures contract or an
options seller to ensure performance of
the term of the contract. Margin in
commodities is not a payment of equity
or down payment on the commodity
itself, but rather it is a security deposit.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margin
1
'Return on margin' (ROM) is often used to
judge performance because it represents
the gain or loss compared to the
exchange’s perceived risk as reflected in
required margin. ROM may be calculated
(realized return) / (initial margin). The
Annualized ROM is equal to
(ROM+1)(year/trade_duration)-1. For
example if a trader earns 10% on margin
in two months, that would be about 77%
annualized.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Settlement - physical versus cash-settled futures
Settlement is the act of
wikt:consummating|consummating
the contract, and can be done in one of
two ways, as specified per type of
futures contract:
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Settlement - physical versus cash-settled futures
1
The Nymex crude futures contract uses this method
of settlement upon expiration
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Settlement - physical versus cash-settled futures
1
how would one deliver an index? A futures
contract might also opt to settle against an
index based on trade in a related spot
market
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Settlement - physical versus cash-settled futures
On this day the t+1
futures contract
becomes the t futures
contract
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Pricing
In this scenario there is only one force
setting the price, which is simple supply
and demand for the asset in the future, as
expressed by supply and demand for the
futures contract.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Arbitrage arguments
Arbitrage arguments (Rational
pricing) apply when the deliverable
asset exists in plentiful supply, or may
be freely created
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Pricing via expectation
In a deep and liquid market, supply and
demand would be expected to balance out
at a price which represents an Expected
value#Uses and applications|unbiased
expectation of the future price of the actual
asset and so be given by the simple
relationship.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Relationship between arbitrage arguments and expectation
1
The expectation based relationship will
also hold in a no-arbitrage setting when
we take expectations with respect to
the risk-neutral probability. In other
words: a futures price is Martingale
(probability theory)|martingale with
respect to the risk-neutral probability.
With this pricing rule, a speculator is
expected to break even when the
futures market fairly prices the
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
1
There are many different kinds of futures
contracts, reflecting the many different
kinds of tradable assets about which the
contract may be based such as
commodities, securities (such as singlestock futures), currencies or intangibles
such as interest rates and indexes. For
information on futures markets in specific
underlying commodity markets, follow the
links. For a list of tradable commodities
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
* Equity
derivative#Equity
futures, options and
swaps|Equity market
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
These forward contracts were private
contracts between buyers and sellers and
became the forerunner to today's
exchange-traded futures contracts
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
1
* CME Group (formerly CBOT and CME) -Currencies, Various Interest Rate
derivatives (including US Bonds);
Agricultural (Corn, Soybeans, Soy
Products, Wheat, Pork, Cattle, Butter,
Milk); Index (Dow Jones Industrial
Average); Metals (Gold, Silver), Index
(NASDAQ, SP, etc.)
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
1
* IntercontinentalExchange (ICE Futures
Europe) - formerly the International
Petroleum Exchange trades energy
including crude oil, heating oil, gas oil
(diesel), refined petroleum products,
electric power, coal, natural gas, and
emissions
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
1
* NYSE Euronext - which absorbed
Euronext into which London
International Financial Futures and
Options Exchange or LIFFE
(pronounced 'LIFE') was merged.
(LIFFE had taken over London
Commodities Exchange (LCE) in
1996)- softs: grains and meats.
Inactive market in Baltic Exchange
shipping. Index futures include
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
1
* South African Futures
Exchange - SAFEX
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
* Tokyo Stock Exchange
TSE (JGB Futures, TOPIX
Futures)
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
* [http://www.tfx.co.jp/en/ Tokyo
Financial Exchange] - TFX - (Euroyen
Futures, OverNight CallRate Futures,
SpotNext RepoRate Futures)
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
1
* Osaka Securities
Exchange OSE
(Nikkei Futures,
RNP Futures)
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
1
* London Metal Exchange - metals: copper,
aluminium, lead, zinc, nickel, tin and steel
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
1
* IntercontinentalExchange (ICE Futures
U.S.) - formerly New York Board of Trade softs: Cocoa bean|cocoa, coffee, cotton,
orange juice, sugar
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
1
* New York Mercantile Exchange CME
Group- energy and metals: crude oil,
gasoline, heating oil, natural gas,
coal, propane, Gold as an
investment|gold, Silver as an
investment|silver, Platinum as an
investment|platinum, copper,
aluminum and Palladium as an
investment|palladium
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contracts and exchanges
1
* ROFEX - Rosario (Argentina)
Futures Exchange
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Who trades futures?
1
In other words, the investor is seeking
exposure to the asset in a long futures
or the opposite effect via a short
futures contract.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Speculators
Dreibus, Tony C.
[http://www.bloomberg.com/news/20
11-06-05/commodity-bubbles-causedby-speculators-need-intervention-unagency-says.html Commodity
Bubbles Caused by Speculators Need
Intervention, UN Agency Says],
Bloomberg, June 5, 2011. Accessed
July 2, 2011
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Speculators
An example that has both hedge and
speculative notions involves a mutual fund
or separately managed account whose
investment objective is to track the
performance of a stock index such as the
SP 500 stock index
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Options on futures
1
A put option|put is the option to sell a
futures contract, and a call option|call is
the option to buy a futures contract
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures contract regulations
All futures transactions in the United
States are regulated by the Commodity
Futures Trading Commission (CFTC),
an Independent agencies of the United
States government|independent agency
of the United States government
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Definition of futures contract
1
Following BjörkBjörk: Arbitrage theory in
continuous time, Cambridge university
press, 2004 we give a definition of a
futures contract. We describe a futures
contract with delivery of item J at the time
T:
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Definition of futures contract
1
* There exists in the market a quoted
price F(t,T), which is known as the
futures price at time t for delivery of J
at time T.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Definition of futures contract
1
* The price of entering a futures
contract is equal to zero.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Definition of futures contract
1
* During any time interval [t,s] , the holder
receives the amount F(s,T) - F(t,T) . (this
reflects instantaneous marking to market)
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Definition of futures contract
1
* At time T, the holder pays F(T,T) and is
entitled to receive J. Note that F(T,T)
should be the spot price of J at time T.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures versus forwards
* Futures are 'Futures
exchange|exchange-traded,' while
forwards are traded 'over-the-counter
(finance)|over-the-counter.'
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures versus forwards
1
*: Thus futures are 'standardized' and face
an 'exchange,' while forwards are
'customized' and face a non-exchange
'counterparty.'
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Futures versus forwards
* Futures are
#Margin|margined,
while forwards are
not.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Exchange versus OTC
Futures are always traded on an
Futures exchange|exchange, whereas
forwards always trade over-thecounter (finance)|over-the-counter, or
can simply be a signed contract
between two parties.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Exchange versus OTC
1
* Futures are highly standardized, being
exchange-traded, whereas forwards can
be unique, being over-the-counter.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Exchange versus OTC
* In the case of physical delivery, the
forward contract specifies to whom to
make the delivery. The counterparty for
delivery on a futures contract is chosen by
the Clearing house (finance)|clearing
house.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
1
Futures are #Margin|margined daily
to the daily spot price of a forward
with the same agreed-upon delivery
price and underlying asset (based on
mark to market).
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
1
The situation for forwards, however,
where no daily true-up takes place in
turn creates 'credit risk' for forwards,
but not so much for futures. Simply
put, the risk of a forward contract is
that the supplier will be unable to
deliver the referenced asset, or that
the buyer will be unable to pay for it
on the delivery date or the date at
which the opening party closes the
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
1
On day 51, that futures
contract costs $90
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
1
:assets the gain or loss accrual|accrues
over the holding period; for a futures this
gain or loss is realized daily, while for a
forward contract the gain or loss remains
unrealized until expiry.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Margining
1
Note that, due to the path dependence
of funding, a futures contract is not,
strictly speaking, a Option
style#American and European
options|European-style derivative:
the total gain or loss of the trade
depends not only on the value of the
underlying asset at expiry, but also on
the path of prices on the way. This
difference is generally quite small
https://store.theartofservice.com/the-futures-contract-toolkit.html
Futures contract - Further reading
1
* [http://www.nfa.futures.org/ The National
Futures Association] (2006).
[http://www.nfa.futures.org/nfa-investorinformation/publication-library/opportunityand-risk-entire.pdf An Educational Guide
to Trading Futures and Options on
Futures]. Chicago, Illinois.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Average true range - Applicability to futures contracts vs. stocks
1
Back-adjustments are often employed
when splicing together individual
monthly futures contracts to form a
continuous futures contract spanning
a long period of time
https://store.theartofservice.com/the-futures-contract-toolkit.html
SPI 200 futures contract
The 'SPI 200 Futures contract' is the
benchmark equity index futures contract in
Australia, based on the SP/ASX 200
Index. It provides all the traditional benefits
of equity index derivatives. The SPI 200 is
ranked in the top 10 equity index contracts
in Asia in terms of traded volume.
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
SPI 200 futures contract
1
Quarterly and serial futures and Option
(finance)|options are available. March,
June, September, December up to six
quarter months ahead and serial months
up to two non-financial quarter months
ahead.
https://store.theartofservice.com/the-futures-contract-toolkit.html
Commodity futures - Futures contracts and exchanges
1
* Montreal Exchange (MX) (owned by
the TMX Group) also known in French
as Bourse De Montreal: Interest Rate
and Cash Derivatives: Canadian 90
Days Bankers' Acceptance Futures,
Canadian Government Bonds futures,
SP/TSX 60 Index Futures, and various
other Index Futures
https://store.theartofservice.com/the-futures-contract-toolkit.html
Eurodollar - Futures contracts
Eurodollars are cash settled futures
contract whose price moves in
response to the interest rate offered on
US Dollar denominated deposits held in
European banks.[http://managedfuturesblog.attaincapital.com/2013/08/21/eurod
ollars-the-biggest-market-youve-neverheard-of/ Attain Capital, Eurodollars:
The Biggest Market You've Never Heard
1
https://store.theartofservice.com/the-futures-contract-toolkit.html
Eurodollar - Futures contracts
Eurodollar futures are a way for
companies and banks to lock in an interest
rate today, for money it intends to borrow
or lend in the future.Wikinvest:Eurodollar
futures|Eurodollar futures on Wikinvest
Each CME Eurodollar futures contract has
a notional or face value of $1,000,000,
though the Leverage (finance)|leverage
used in futures allows one contract to be
traded with a Margin (finance)|margin of
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Eurodollar - Futures contracts
CME Eurodollar futures prices are
determined by the market’s forecast of
the 3-month United States dollar|USD
London Interbank Offered Rate|LIBOR
interest rate expected to prevail on the
settlement date. A price of 95.00 implies
an interest rate of 100.00 - 95.00, or 5%.
The settlement price of a contract is
defined to be 100.00 minus the official
British Bankers' Association fixing of 3month LIBOR on the day the contract is
settled.
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Eurodollar - How the Eurodollar futures contract works
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For example, if on a particular day an
investor buys a single three-month
contract at 95.00 (implied settlement
LIBOR of 5.00%):
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Eurodollar - How the Eurodollar futures contract works
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* if at the close of business on that day,
the contract price has risen to 95.01
(implying a LIBOR decrease to
4.99%), US$25 will be paid into the
investor's margin account; or
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Eurodollar - How the Eurodollar futures contract works
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* if at the close of business on that day,
the contract price has fallen to 94.99
(implying a LIBOR increase to 5.01%),
US$25 will be deducted from the
investor's margin account.
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Eurodollar - How the Eurodollar futures contract works
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On the settlement date, the settlement
price is determined by the actual
LIBOR fixing for that day rather than a
market-determined contract price.
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Eurodollar - Eurodollar futures contract as synthetic loan
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A single Eurodollar future is similar to a
forward rate agreement to borrow or
lend US$1,000,000 for three months
starting on the contract settlement
date. Buying the contract is equivalent
to lending money, and selling the
contract short is equivalent to
borrowing money.
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Eurodollar - Eurodollar futures contract as synthetic loan
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Consider an investor who agreed to lend
US$1,000,000 on a particular date for
three months at 5.00% per annum
(months are calculated on a 30/360 basis).
Interest received in 3 months' time would
be US$1,000,000 × 5.00% × 90 / 360 =
US$12,500.
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Eurodollar - Eurodollar futures contract as synthetic loan
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* If the following day, the investor is able to
lend money from the same start date at
5.01%, s/he would be able to earn
US$1,000,000 × 5.01% × 90 / 360 =
US$12,525 of interest. Since the investor
only is earning US$12,500 of interest, s/he
has lost US$25 as a result of interest rate
moves.
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Eurodollar - Eurodollar futures contract as synthetic loan
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* On the other hand, if the following day,
the investor is able to lend money from the
same start date only at 4.99%, s/he would
be able to earn only US$1,000,000 ×
4.99% × 90 / 360 = US$12,475 of interest.
Since the investor is in fact earning
US$12,500 of interest, s/he has gained
US$25 as a result of interest rate moves.
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Eurodollar - Eurodollar futures contract as synthetic loan
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* In an actual loan, the US$25 per basis
point is earned or lost at the end of the
three-month loan, not up front
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Eurodollar - Eurodollar futures contract as synthetic loan
* In an actual loan, the lender takes
credit risk to a borrower. In Eurodollar
futures, the principal of the loan is
never disbursed, so the credit risk is
only on the margin account balance.
Moreover, even that risk is the risk of
the Clearing house
(finance)|clearinghouse, which is
considerably lower than even
unsecured single-A credit risk.
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