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A currency future, also FX futureor foreign exchange future, is afutures
contractto exchange onecurrencyfor another at a specified date in the future at
a price (exchange rate)that is fixed on the purchase date; seeForeign exchange
derivative.Typically, one of the currencies is theUS dollar.Thepriceof a future
is then in terms of US dollars per unit of other currency. This can be differentfrom the standard way of quoting in the spotforeign exchange markets.
The trade unitof each contract is then a certain amount of other currency, for
instance 125,000. Most contracts have physical delivery, so for those held at
the end of the last trading day, actual payments are made in each currency.
However, most contracts are closed out before that. Investors can close out the
contract at any time prior to the contract's delivery date.
In finance, a forward contractor simply a forwardis a non-standardized
contract between two parties to buy or to sell an asset at a specified future time
at a price agreed upon today.[1]This is in contrast to aspot contract,which is an
agreement to buy or sell an asset today. The party agreeing to buy the
underlying asset in the future assumes along position,and the party agreeing to
sell the asset in the future assumes ashort position.The price agreed upon is
called thedelivery price,which is equal to theforward priceat the time the
contract is entered into.
The price of the underlying instrument, in whatever form, is paid before control of
the instrument changes. This is one of the many forms of buy/sell orders where
the time and date of trade is not the same as thevalue datewhere
thesecuritiesthemselves are exchanged.
Theforward priceof such a contract is commonly contrasted with thespot price,
which is the price at which the asset changes hands on thespot date.The
difference between the spot and the forward price is theforward premiumor
forward discount, generally considered in the form of aprofit,or loss, by the
purchasing party.
Forwards, like other derivative securities, can be used tohedgerisk (typically
currency or exchange rate risk), as a means ofspeculation,or to allow a party to
take advantage of a quality of the underlying instrument which is time-sensitive.
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A closely related contract is afutures contract;theydiffer in certain respects.
Forward contracts are very similar to futures contracts, except they are not
exchange-traded, or defined on standardized assets.[2]Forwards also typically
have no interim partial settlements or "true-ups" in margin requirements like
futuressuch that the parties do not exchange additional property securing the
party at gain and the entire unrealized gain or loss builds up while the contract is
open. However, being tradedover the counter (OTC),forward contracts
specification can be customized and may include mark-to-market and daily
margin calls. Hence, a forward contract arrangement might call for the loss party
to pledge collateral or additional collateral to better secure the party at
gain.[clarification needed]In other words, the terms of the forward contract will
determine the collateral calls based upon certain "trigger" events relevant to a
particular counterparty such as among other things, credit ratings, value of
assets under management or redemptions over a specific time frame, e.g.,
quarterly, annually, etc.
What is the difference between forward and futures
contracts?
Fundamentally, forward and futures contracts have the same
function: both types of contracts allow people to buy or sell a
specific type of asset at a specific time at a given price.
However, it is in the specific details that these contractsdiffer. First of all,futures contractsare exchange-traded and,
therefore, are standardized contracts.Forward contracts, on
the other hand, are private agreements between two parties
and are not as rigid in their stated terms and conditions.
Because forward contracts are private agreements, there is
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always a chance that a party maydefaulton its side of the
agreement. Futures contracts haveclearing housesthat
guarantee the transactions, which drastically lowers the
probability of default to almost never.
Secondly, the specific details concerning settlement
anddeliveryare quite distinct. For forward contracts,
settlement of the contract occurs at the end of the contract.
Futures contracts aremarked-to-marketdaily, which means
that daily changes are settled day by day until the end of the
contract. Furthermore, settlement for futures contracts can
occur over a range of dates. Forward contracts, on the otherhand, only possess one settlement date.
Lastly, because futures contracts are quite frequently
employed byspeculators, who bet on the direction in which
an asset's price will move, they are usually closed out prior
to maturity and delivery usually never happens. On the other
hand, forward contracts are mostly used by hedgers that
want to eliminate the volatilityof an asset's price, and
delivery of the asset or cash settlementwill usually take
place.
Derivatives: A derivative is an instrument whose value is derived from the value of one or more
basic variables called bases (underlying asset, index, or reference rate) in a contractual
manner. The underlying asset can be equity, commodity, forex or any other asset. The majorfinancial derivative products are Forwards, Futures, Options and Swaps. We will start with the
concept of a Forward contract and then move on to understand Future and Option contracts.
Forward Contracts: A forward contract is an agreement to buy or sell an asset on a specified
date for a specified price. The main features of this definition are There is an agreement
Agreement is to buy or sell the underlying asset The transaction takes place on a predetermined
future date The price at which the transaction will take place is also predetermined Let us
illustrate it with an example. Suppose an IT company exports its services to US and hence
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earns its revenue in Dollars. If it knows it would receive a payment of $1 million in six months
time, it cannot be sure as to what would be the Rupee value of this $1 million after six months.
Assuming that the current rate is Rs 43/$, the value as per current rate would be Rs 43 million.
Now suppose the actual forex rate after six months is Rs 37/$ and hence the company receives
Rs 37 million which is less by almost 14% that the current value. In the reverse scenario of
rupee depreciating vis--vis the dollar, a rate of Rs 45/$ would lead to a gain of Rs 2 million.Hence, the company is exposed to currency risk. To hedge this risk, the company may sell
dollar forward i.e. it may enter into an agreement to sell $1 mn after 6 months at a rate of Rs
43/$. Note that it satisfies all the conditions of a forward contract. One pre-requisite of a forward
contract is that there should be another party which is willing to take a reverse position. For
example, in the above case we may sell dollars forward only if someone is willing to buy it after
six months. An importer who purchases goods and hence makes payment in dollars might need
to hedge his currency risk by being the other side of this contract. Future Contracts: A future
contract is effectively a forward contract which is standardized in nature and is exchange traded.
Future contracts remove the lacunas of forward contracts as they are not exposed to
counterparty risk and are also much more liquid. The standardization of the contract is with
respect to Quality of underlying Quantity of underlying Term of the contract Let us understand it
with the help of an illustration of a Reliance Future contract. What does the statement - I have
bought 1 lot (250 shares) of Reliance July Future @ Rs 700 meanin theory? It means that the
person has agreed to buy 250 shares of Reliance Industries on 26th July 2012 (the expiration
date) at Rs 700 per share. Here, The underlying is the shares of Reliance Industries The
quantity is 1 lot, i.e. 250 shares The expiry date is 26th July 2012 (last Thursday of July), and
The pre-determined price is Rs 700 (and is called the Strike Price) If the actual price of Reliance
is Rs 800 on the settlement day (26th July), the person buys 250 shares at the contracted price
of Rs 700 and may sell it at the prevailing market price of Rs 800 thereby gaining Rs 100 per
share (Rs 25,000 in total). On the other hand if the price falls to 650 he loses Rs 50 per share
(Rs 12,500 in total) as he has to buy at Rs 700 but the prevailing market price is Rs 650.
Derivatives - Common Characteristics of Futures
and Forwards
Forward CommitmentsA forward commitment is a contract between two (or more)
parties who agree to engage in a transaction at a later date
and at a specific price, which is given at the start of the
contract. It is a customized, privately negotiated agreement
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to exchange an asset or cash flows at a specified future date
at a price agreed on at the trade date. In its simplest form, it
is a trade that is agreed to at one point in time but will take
place at some later time. For example, two parties might
agree today to exchange 500,000 barrels of crude oil for
$42.08 a barrel three months from today. Entering a forward
contract typically does notrequire the payment of a fee.
There are two major types of forward commitments:
Forward contracts, orforwards, are OTC-tradedderivatives with customized terms and features.
Futures contract, orfutures,are exchange-traded
derivatives with standardized terms.
Futures and forwards share some common characteristics:
Both futures and forwards are firm and binding
agreements to act at a later date. In most cases this
means exchanging an asset at a specific price sometime
in the future.
Both types of derivatives obligate the parties to make a
contract to complete the transaction or offset the
transaction by engaging in anther transaction thatsettles each party's obligation to the other. Physical
settlement occurs when the actual underlying asset is
delivered in exchange for the agreed-upon price. In
cases where the contracts are entered into for purely
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financial reasons (i.e. the engaged parties have no
interest in taking possession of the underlying asset),
the derivative may becash settledwith a single payment
equal to the market value of the derivative at its
maturity or expiration.
Both types of derivatives are considered leveraged
instruments because for little or no cash outlay, an
investor can profit from price movements in the
underlying asset without having to immediately pay for,
hold or warehouse that asset.
They offer a convenient means of hedging or
speculating. For example, a rancher can conveniently
hedge his grain costs by purchasing corn several months
forward. The hedge eliminates price exposure, and it
doesn't require an initial outlay of funds to purchase the
grain. The rancher is hedged without having to take
delivery of or store the grain until it is needed. Therancher doesn't even have to enter into the forward with
the ultimate supplier of the grain and there is little or no
initial cash outlay.
Both physical settlement and cash settlement options
can be keyed to a wide variety of underlying assets
including commodities, short-term debt, Eurodollar
deposits, gold, foreign exchange, the S&P 500 stockindex, etc.
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Derivatives - The Futures Trade Process
Most U.S. futures exchanges offer two ways to enact a trade
- the traditional floor-trading process (also called "open
outcry") and electronic trading. The basic steps are
essentially the same in either format: Customers submit
orders that are executed - filled - by other traders who take
equal but opposite positions, selling at prices at which other
customers buy or buying at prices at which other customerssell. The differences are described below.
Open outcry trading is the more traditional form of trading in
the U.S. Brokers take orders (either bids to buy or offers to
sell) by telephone or computer from traders (their
customers). Those orders are then communicated orally to
brokers in a trading pit. The pits are octagonal, multi-tiered
areas on the floor of the exchange where traders conduct
business. The traders wear different colored jackets and
badges that indicate who they work for and what type of
traders they are (FCM or local). It's called "open outcry"
because traders shout and use various hand signals to relay
information and the price at which they are willing to trade.
Trades are executed (matches are made) when the traders
agree on a price and the number of contracts either through
verbal communication or simply some sort of motion such as
a nod. The traders then turn their trade tickets over to their
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clerks who enter the transaction into the system. Customers
are then notified of their trades and pertinent information
about each trade is sent to the clearing house and
brokerages.
In electronic trading, customers (who have been pre-
approved by a brokerage for electronic trading) send buy or
sell orders directly from their computers to an electronic
marketplace offered by the relevant exchange. There are no
brokers involved in the process. Traders see the various bids
and offers on their computers. The trade is executed by the
traders lifting bids or hitting offers on their computer
screens. The trading pit is, in essence, the trading screen and
the electronic market participants replace the brokers
standing in the pit. Electronic trading offers much greater
insight into pricing because the top five current bids and
offers are posted on the trading screen for all marketparticipants to see. Computers handle all trading activity -
the software identifies matches of bids and offers and
generally fills orders according to a first-in, first-out (FIFO)
process. Dissemination of information is also faster on
electronic trades. Trades made on CME Globex, for
example, happen in milliseconds and are instantaneously
broadcast to the public. In open outcry trading, however, itcan take from a few seconds to minutes to execute a trade.
Price Limit
This is the amount a futures contract's price can move in one
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day. Price limits are usually set in absolute dollar amounts -
the limit could be $5, for example. This would mean that the
price of the contract could not increase or decrease by more
than $5 in a single day.
Limit Move
A limit move occurs when a transaction takes place that
would exceed the price limit. This freezes the price at the
price limit.
Limit Up
The maximum amount by which the price of a futures
contract may advance in one trading day. Some markets
close trading of these contracts when the limit up is reached,
others allow trading to resume if the price moves away from
the day's limit. If there is a major event affecting the
market's sentiment toward a particular commodity, it maytake several trading days before the contract price fully
reflects this change. On each trading day, the trading limit
will be reached before the market's equilibrium contract price
is met.
Limit Down
This is when the price decreases and is stuck at the lowerprice limit. The maximum amount by which the price of a
commodity futures contract may decline in one trading
day. Some markets close trading of contracts when the limit
down is reached, others allow trading to resume if the price
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moves away from the day's limit. If there is a major event
affecting the market's sentiment toward a particular
commodity, it may take several trading days before the
contract price fully reflects this change. On each trading day,
the trading limit will be reached before the market's
equilibrium contract price is met.
Locked Limit
Occurs when the trading price of a futures contract arrives at
the exchange's predetermined limit price. At the lock limit,
trades above or below the lock price are not executed. For
example, if a futures contract has a lock limit of $5, as soon
as the contract trades at $5 the contract would no longer be
permitted to trade above this price if the market is on an
uptrend, and the contract would no longer be permitted to
trade below this price if the market is on a downtrend. The
main reason for these limits is to prevent investors fromsubstantial losses that can occur as a result of the volatility
found in futures markets.
The Marking to Market Process
At the initiation of the trade, a price is set and money is
deposited in the account.
At the end of the day, a settlement price is determined
by the clearing house. The account is then adjusted
accordingly, either in a positive or negative manner,
with funds either being drawn from or added to the
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account based on the difference in the initial price and
the settlement price.
The next day, the settlement price is used as the base
price.
As the market prices change through the next day, a
new settlement price will be determined at the end of
the day. Again, the account will be adjusted by the
difference in the new settlement price and the previous
night's price in the appropriate manner.
Infinance,a futures contract(more colloquially, futures) is astandardizedcontractbetween 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. The contracts are negotiated at afutures exchange,which acts as an
intermediary between the two parties. The party agreeing to buy the underlying
asset in the future, the "buyer" of the contract, is said to be "long", and the party
agreeing to sell the asset in the future, the "seller" of the contract, is said to be
"short".
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. Thus the exchange requires both parties to put up an
initial amount of cash (performance bond), themargin.Additionally, since the
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futures price will generally change daily, the difference in the prior agreed-upon
price and the daily futures price is settled daily also (variation margin). The
exchange will draw money out of one party's margin account and put it into the
other's so that each party has the appropriate daily loss or profit. If the margin
account goes below a certain value, then a margin call is made and the account
owner must replenish the margin account. This process is known as marking to
market. Thus on the delivery date, the amount exchanged is not the specified
price on the contract but thespot value(i.e. the original value agreed upon, since
any gain or loss has already been previously settled by marking to market).
A closely related contract is aforward 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 theinterim partial payments due to marking to market. Nor is the contract
standardized, as on the exchange.
Unlike anoption,both parties of a futures contract must fulfill the contract on the
delivery date. The seller delivers the underlying asset to the buyer, or, if it is a
cash-settled futures contract, then cash is transferred from the futures trader who
sustained a loss to the one who made a profit. To exit the commitment prior to
the settlement date, the holder of a futurespositioncan close out its contract
obligations by taking the opposite position on another futures contract on the
same asset and settlement date. The difference in futures prices is then a profit
or loss.
Contents
[hide]
1 Origin
2 Margin 3 Settlement - physical versus cash-settled futures
4 Pricing
o 4.1 Arbitrage arguments
o 4.2 Pricing via expectation
o 4.3 Relationship between arbitrage arguments and expectation
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o 4.4 Contango and backwardation
5 Futures contracts and exchanges
o 5.1 Codes
6 Who trades futures?
o 6.1 Hedgers
o 6.2 Speculators
7 Options on futures
8 Futures contract regulations
9 Definition of futures contract
10 Futures versus forwards
o 10.1 Exchange versus OTC
o 10.2 Margining
11 Further reading
12 See also
13 Notes
14 References
15 U.S. Futures exchanges and regulators
16 External links
Origin[edit]
The first futures exchange market was theDjima Rice Exchangein Japan in the
1730s, to meet the needs ofsamuraiwhobeing paid in rice, and after a series
of bad harvestsneeded a stable conversion to coin.[1]
TheChicago Board of Trade(CBOT) listed the first ever standardized 'exchange
traded' forward contracts in 1864, which were called futures contracts. This
contract was based ongraintrading and started a trend that saw contracts
created on a number of differentcommoditiesas well as a number of futures
exchanges set up in countries around the world.
[2]
By 1875 cotton futures werebeing traded inMumbaiin India and within a few years this had expanded to
futures onedible oilseeds complex,rawjuteand jute goods andbullion.[3]
Margin[edit]
Main article:Margin (finance)
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To minimizecredit riskto the exchange, traders must post amarginor
aperformance bond,typically 5%-15% of the contract's value.
To minimizecounterparty riskto 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 performingdue diligenceon their counterparty.
Margin requirements are waived or reduced in some cases forhedgerswho have
physical ownership of the coveredcommodityorspread traderswho have
offsetting contracts balancing the position.
Clearing marginare 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.
Customer marginWithin 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 Merchantsare
responsible for overseeing customer margin accounts. Margins are determined
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on the basis of market risk and contract value. Also referred to as performance
bond margin.
Initial marginis 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 theinitial 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.
If a position involves an exchange-traded product, the amount or percentage of
initial margin is set by the exchange concerned.
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.
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 closed-out the client is liable for any
resulting deficit in the clients account.
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.
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).
A futures account is marked to market daily. If the margin drops below the marginmaintenance requirement established by the exchange listing the futures, a
margin call will be issued to bring the account back up to the required level.
Maintenance marginA set minimum margin per outstanding futures contract
that a customer must maintain in their margin account.
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Margin-equity ratiois a term used byspeculators,representing the amount of
their trading capital that is being held as margin at any particular time. The low
margin requirements of futures results in substantial leverage of the investment.
However, the exchanges require a minimum amount that varies depending on
the contract and the trader. The broker may set the requirement higher, but may
not set it lower. A trader, of course, can set it above that, if he does not want to
be subject to margin calls.
Performance bond marginThe 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.
Return on margin(ROM) is often used to judge performance because it
represents the gain or loss compared to the exchanges 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.
Settlement - physical versus cash-settled futures[edit]
Settlement is the act ofconsummatingthe contract, and can be done in one of
two ways, as specified per type of futures contract:
Physical delivery- the amount specified of the underlying asset of the
contract is delivered by the seller of the contract to the exchange, and by the
exchange to the buyers of the contract. Physical delivery is common with
commodities and bonds. In practice, it occurs only on a minority of contracts.
Most are cancelled out by purchasing a covering position - that is, buying a
contract to cancel out an earlier sale (covering a short), or selling a contract to
liquidate an earlier purchase (covering a long). The Nymex crude futures
contract uses this method of settlement upon expiration
Cash settlement- a cash payment is made based on the
underlyingreference rate,such as a short term interest rate index such as90
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Day T-Bills,or the closing value of astock market index.The parties settle by
paying/receiving the loss/gain related to the contract in cash when the
contract expires.[4]Cash settled futures are those that, as a practical matter,
could not be settled by delivery of the referenced item - i.e. 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. ICE Brent futures use this method.
Expiry(or Expirationin the U.S.) is the time and the day that a particular
delivery month of a futures contract stops trading, as well as the final settlement
price for that contract. For many equity index and interest rate futures contracts
(as well as for most equity options), this happens on the third Friday of certain
trading months. On this day the t+1futures contract becomes the tfutures
contract. For example, for mostCMEandCBOTcontracts, at the expiration ofthe December contract, the March futures become the nearest contract. This is
an exciting time for arbitrage desks, which try to make quick profits during the
short period (perhaps 30 minutes) during which theunderlyingcash price and the
futures price sometimes struggle to converge. At this moment the futures and the
underlying assets are extremely liquid and any disparity between an index and
an underlying asset is quickly traded by arbitrageurs. At this moment also, the
increase in volume is caused by traders rolling over positions to the next contract
or, in the case of equity index futures, purchasing underlying components ofthose indexes to hedge against current index positions. On the expiry date, a
European equity arbitrage trading desk in London or Frankfurt will see positions
expire in as many as eight major markets almost every half an hour.
Pricing[edit]
When the deliverable asset exists in plentiful supply, or may be freely created,
then the price of a futures contract is determined viaarbitragearguments. This is
typical forstock index futures,treasury bond futures,andfutures on physical
commoditieswhen they are in supply (e.g. agricultural crops after the harvest).
However, when the deliverable commodity is not in plentiful supply or when it
does not yet exist - for example on crops before the harvest or
onEurodollarFutures orFederal funds ratefutures (in which the supposed
underlying instrument is to be created upon the delivery date) - the futures price
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cannot be fixed by arbitrage. In this scenario there is only one force setting the
price, which is simplesupply and demandfor the asset in the future, as
expressed by supply and demand for the futures contract.
Arbitrage arguments[edit]Arbitrage arguments ("Rational pricing") apply when the deliverable asset exists
in plentiful supply, or may be freely created. Here, the forward price represents
the expected future value of the underlyingdiscountedat therisk free rateas
any deviation from the theoretical price will afford investors a riskless profit
opportunity and should be arbitraged away. We define the forward price to be the
strike K such that the contract has 0 value at the present time. Assuming interest
rates are constant the forward price of the future is equal to the forward price of
the forward contract with the same strike and maturity. It is also the same if the
underlying asset is uncorrelated with interest rates. Otherwise the difference
between the forward price on the future (futures price) and forward price on the
asset, is proportional to the covariance between the underlying asset price and
interest rates. For example, a future on a zero coupon bond will have a futures
price lower than the forward price. This is called the futures "convexity
correction."
Thus, assuming constant rates, for a simple, non-dividend paying asset, thevalue of the future/forward price, F(t,T), will be found by compounding the
present value S(t)at time tto maturity Tby the rate of risk-free return r.
or, withcontinuous compounding
This relationship may be modified for storage costs, dividends, dividend
yields, and convenience yields.
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
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futures price in fact varies within arbitrage boundaries around the
theoretical price.
Pricing via expectation[edit]
When the deliverable commodity is not in plentiful supply (or when it doesnot yet exist) rational pricing cannot be applied, as the arbitrage
mechanism is not applicable. Here the price of the futures is determined
by today'ssupply and demandfor the underlying asset in the future.
In a deep and liquid market, supply and demand would be expected to
balance out at a price which represents anunbiased expectationof the
future price of the actual asset and so be given by the simple relationship.
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 ascornering
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 the expected future price of the asset can break down.
Relationship between arbitrage arguments andexpectation[edit]
The expectation based relationship will also hold in a no-arbitrage
setting when we take expectations with respect to therisk-neutral
probability.In other words: a futures price ismartingalewith 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.
Contango and backwardation[edit]
The situation where the price of a commodity for future delivery is
higher than thespot price,or where a far future delivery price is higher
than a nearer future delivery, is known ascontango.The reverse,
where the price of a commodity for future delivery is lower than the
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spot price, or where a far future delivery price is lower than a nearer
future delivery, is known asbackwardation.
Futures contracts and exchanges[edit]
Contracts
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 assingle-stock futures),
currencies or intangibles such as interest rates and indexes. For
information on futures markets in specific underlyingcommodity
markets,follow the links. For a list of tradable commodities futures
contracts, seeList of traded commodities.See also thefuturesexchangearticle.
Foreign exchange market
Money market
Bond market
Equity market
Soft Commodities market
Trading oncommoditiesbegan in Japan in the 18th century with the
trading of rice and silk, and similarly in Holland with tulip bulbs. Trading
in the US began in the mid 19th century, when central grain markets
were established and a marketplace was created for farmers to bring
their commodities and sell them either for immediate delivery (also
called spot or cash market) or for forward delivery. These forward
contracts were private contracts between buyers and sellers and
became the forerunner to today's exchange-traded futures contracts.
Although contract trading began with traditional commodities such as
grains, meat and livestock, exchange trading has expanded to include
metals, energy, currency and currency indexes, equities and equity
indexes, government interest rates and private interest rates.
Exchanges
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Contracts on financial instruments were introduced in the 1970s by
theChicago 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. This
innovation led to the introduction of many new futures exchanges
worldwide, such as theLondon International Financial Futures
Exchangein 1982 (nowEuronext.liffe), Deutsche Terminbrse
(nowEurex)and theTokyo Commodity Exchange(TOCOM). Today,
there are more than 90 futures and futures options exchanges
worldwide trading to include:
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.)
IntercontinentalExchange(ICE Futures Europe) - formerly
theInternational Petroleum Exchangetrades energy
includingcrude oil,heating oil, gas oil (diesel), refined petroleum
products, electric power, coal,natural gas,and emissions
NYSE Euronext- which absorbedEuronextinto whichLondon
International Financial Futures and Options
ExchangeorLIFFE(pronounced 'LIFE') was merged. (LIFFE had
taken over London Commodities Exchange ("LCE") in 1996)- softs:
grains and meats. Inactive market inBaltic Exchangeshipping.
Index futures includeEURIBOR,FTSE 100,CAC 40,AEX index.
South African Futures Exchange - SAFEX
Sydney Futures Exchange Tokyo Stock ExchangeTSE (JGB Futures, TOPIX Futures)
Tokyo Commodity ExchangeTOCOM
Tokyo Financial Exchange- TFX - (Euroyen Futures, OverNight
CallRate Futures, SpotNext RepoRate Futures)
Osaka Securities ExchangeOSE (Nikkei Futures, RNP Futures)
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London Metal Exchange-
metals:copper,aluminium,lead,zinc,nickel,tinand steel
IntercontinentalExchange(ICE Futures U.S.) - formerly New York
Board of Trade - softs:cocoa,coffee,cotton,orange juice,sugar
New York Mercantile ExchangeCME Group- energy and
metals:crude oil,gasoline,heating oil,natural
gas,coal,propane,gold,silver,platinum,copper,aluminumandpall
adium
Dubai Mercantile Exchange
Korea Exchange- KRX
Singapore Exchange- SGX - into which mergedSingapore
International Monetary Exchange(SIMEX) ROFEX- Rosario (Argentina) Futures Exchange
NCDEX- National Commodity and Derivatives Exchange, India
Codes[edit]
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.
Third (month) futures contract codes are
January = F
February = G
March = H
April = J
May = K
June = M
July = N
August = Q
September = U
October = V
November = X
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dia.org/wiki/Crude_oilhttp://en.wikipedia.org/wiki/New_York_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Sugarhttp://en.wikipedia.org/wiki/Orange_juicehttp://en.wikipedia.org/wiki/Cottonhttp://en.wikipedia.org/wiki/Coffeehttp://en.wikipedia.org/wiki/Cocoa_beanhttp://en.wikipedia.org/wiki/IntercontinentalExchangehttp://en.wikipedia.org/wiki/Tinhttp://en.wikipedia.org/wiki/Nickelhttp://en.wikipedia.org/wiki/Zinchttp://en.wikipedia.org/wiki/Leadhttp://en.wikipedia.org/wiki/Aluminiumhttp://en.wikipedia.org/wiki/Copperhttp://en.wikipedia.org/wiki/London_Metal_Exchange7/27/2019 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December = Z
Example: CLX14 is a Crude Oil (CL), November (X) 2014 (14)
contract.[5]
Who trades futures?[edit]Futures traders are traditionally placed in one of two groups:hedgers,
who have an interest in the underlying asset (which could include an
intangible such as an index or interest rate) and are seeking to hedge
outthe risk of price changes; andspeculators,who seek to make a
profit by predicting market moves and opening aderivativecontract
related to the asset "on paper", while they have no practical use for or
intent to actually take or make delivery of the underlying asset. In otherwords, the investor is seeking exposure to the asset in a long futures or
the opposite effect via a short futures contract.
Hedgers[edit]
Hedgers typically include producers andconsumersof a commodity or
the owner of an asset or assets subject to certain influences such as
an interest rate.
For example, in traditionalcommodity markets,farmersoften sellfutures contracts for the crops and livestock they produce to guarantee
a certain price, making it easier for them to plan. Similarly, livestock
producers often purchase futures to cover their feed costs, so that they
can plan on a fixed cost for feed. In modern (financial) markets,
"producers" ofinterest rate swapsorequity derivativeproducts will use
financial futures or equity index futures to reduce or remove the risk on
theswap.
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 non-competitive (for
example see:VeraSun Energy).
http://en.wikipedia.org/wiki/Futures_contract#cite_note-5http://en.wikipedia.org/wiki/Futures_contract#cite_note-5http://en.wikipedia.org/wiki/Futures_contract#cite_note-5http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit§ion=11http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit§ion=11http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit§ion=11http://en.wikipedia.org/wiki/Hedge_(finance)http://en.wikipedia.org/wiki/Hedge_(finance)http://en.wikipedia.org/wiki/Hedge_(finance)http://en.wikipedia.org/wiki/Speculatorhttp://en.wikipedia.org/wiki/Speculatorhttp://en.wikipedia.org/wiki/Speculatorhttp://en.wikipedia.org/wiki/Derivative_(finance)http://en.wikipedia.org/wiki/Derivative_(finance)http://en.wikipedia.org/wiki/Derivative_(finance)http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit§ion=12http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit§ion=12http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit§ion=12http://en.wikipedia.org/wiki/Consumerhttp://en.wikipedia.org/wiki/Consumerhttp://en.wikipedia.org/wiki/Consumerhttp://en.wikipedia.org/wiki/Commodity_markethttp://en.wikipedia.org/wiki/Commodity_markethttp://en.wikipedia.org/wiki/Commodity_markethttp://en.wikipedia.org/wiki/Farmerhttp://en.wikipedia.org/wiki/Farmerhttp://en.wikipedia.org/wiki/Farmerhttp://en.wikipedia.org/wiki/Interest_rate_swapshttp://en.wikipedia.org/wiki/Interest_rate_swapshttp://en.wikipedia.org/wiki/Interest_rate_swapshttp://en.wikipedia.org/wiki/Equity_derivativehttp://en.wikipedia.org/wiki/Equity_derivativehttp://en.wikipedia.org/wiki/Equity_derivativehttp://en.wikipedia.org/wiki/Swap_(finance)http://en.wikipedia.org/wiki/Swap_(finance)http://en.wikipedia.org/wiki/Swap_(finance)http://en.wikipedia.org/wiki/VeraSun_Energyhttp://en.wikipedia.org/wiki/VeraSun_Energyhttp://en.wikipedia.org/wiki/VeraSun_Energyhttp://en.wikipedia.org/wiki/VeraSun_Energyhttp://en.wikipedia.org/wiki/Swap_(finance)http://en.wikipedia.org/wiki/Equity_derivativehttp://en.wikipedia.org/wiki/Interest_rate_swapshttp://en.wikipedia.org/wiki/Farmerhttp://en.wikipedia.org/wiki/Commodity_markethttp://en.wikipedia.org/wiki/Consumerhttp://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit§ion=12http://en.wikipedia.org/wiki/Derivative_(finance)http://en.wikipedia.org/wiki/Speculatorhttp://en.wikipedia.org/wiki/Hedge_(finance)http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit§ion=11http://en.wikipedia.org/wiki/Futures_contract#cite_note-57/27/2019 ifmm
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Speculators[edit]
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 futuresmarkets in recent years controversy has risen about whether
speculators are responsible for increased volatility in commodities like
oil, and experts are divided on the matter.[6]
An example that has both hedge and speculative notions involves
amutual fundorseparately managed accountwhose investment
objective is to track the performance of a stock index such as the S&P
500 stock index. ThePortfolio manageroften "equitizes" cash inflows
in an easy and cost effective manner by investing in (opening long)
S&P 500 stock index futures. This gains the portfolio exposure to the
index which is consistent with the fund or account investment objective
without having to buy an appropriate proportion of each of the
individual 500 stocks just yet. This also preserves balanced
diversification, maintains a higher degree of the percent of assets
invested in the market and helps reducetracking errorin the
performance of the fund/account. When it is economically feasible (an
efficient amount of shares of every individual position within the fund or
account can be purchased), the portfolio manager can close the
contract and make purchases of each individual stock.
The social utility of futures markets is considered to be mainly in the
transfer ofrisk,and increased liquidity between traders with different
risk andtime preferences,from a hedger to a speculator, for
example.[citation needed]
Options on futures[edit]In many cases,optionsare traded on futures, sometimes called simply
"futures options". Aputis the option to sell a futures contract, and
acallis the option to buy a futures contract. For both, the optionstrike
priceis the specified futures price at which the future is traded if the
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