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8/10/2019 Assignment 2 Chapter 8
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Assignment 2Chapter 8
Major Futures Exchanges Margin Requirements &
Types of Underlying Assets
Hatem Hassan Zakaria
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A.Futures contract
A.Definition
a futures contract(more colloquially, futures) is a standardized contract between twoparties to buy or sell a specified asset of standardized quantity and quality for a priceagreed upon today (thefutures price) with delivery and payment occurring at a specifiedfuture date, the delivery date, making it a type of derivative instrument. The contracts arenegotiated at a futures 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, issaid to be "long", and the party agreeing to sell the asset in the future, the "seller" of thecontract, is said to be "short".
While the futures contract specifies a trade taking place in the future, the purpose of thefutures exchange institution is to act as intermediary and minimize the risk of default byeither party. Thus the exchange requires both parties to put up an initial amount of cash(performance bond), the margin.
Additionally, since the futures price will generally change daily, the difference in theprior 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 theother's so that each party has the appropriate daily loss or profit. If the margin accountgoes below a certain value, then a margin call is made and the account owner mustreplenish the margin account.
This process is known as marking to market. Thus on the delivery date, the amountexchanged is not the specified price on the contract but the spot value (i.e. the originalvalue agreed upon, since any gain or loss has already been previously settled by markingto market).
A closely related contract is a forward contract. A forward is like a futures in that itspecifies 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 partialpayments due to marking to market. Nor is the contract standardized, as on the exchange.
Unlike an option, both parties of a futures contract must fulfill the contract on thedelivery 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 aloss to the one who made a profit. To exit the commitment prior to the settlement date,the holder of a futures position can close out its contract obligations by taking theopposite position on another futures contract on the same asset and settlement date. Thedifference in futures prices is then a profit or loss.
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Future contracts are also agreements between two parties in which the buyer agrees to
buy an underlying asset from the other party (the seller). The delivery of the asset occurs
at a later time, but the price is determined at the time of purchase.
Terms and conditions are standardized. Trading takes place on a formal exchange wherein the exchange provides a place
to engage in these transactions and sets a mechanism for the parties to trade these
contracts.
There is no default risk because the exchange acts as a counterparty, guaranteeing
delivery and payment by use of a clearing house.
The clearing house protects itself from default by requiring its counterparties to
settle gains and losses or mark to market their positions on a daily basis.
Futures are highly standardized, have deep liquidity in their markets and trade on
an exchange.
An investor can offset his or her future position by engaging in an opposite
transaction before the stated maturity of the contract.
Example: Future Contracts
Let's assume that in September the spot or current price for hydroponic tomatoes is $3.25per bushel and the futures price is $3.50. A tomato farmer is trying to secure a selling
price for his next crop, while McDonald's is trying to secure a buying price in order todetermine how much to charge for a Big Mac next year. The farmer and the corporationcan enter into a futures contract requiring the delivery of 5 million bushels of tomatoes toMcDonald's in December at a price of $3.50 per bushel. The contract locks in a price forboth parties. It is this contract - and not the grain per se - that can then be bought and soldin the futures market.
In this scenario, the farmer is the holder of the short position (he has agreed to sell theunderlying asset - tomatoes) and McDonald's is the holder of the long position (it hasagreed to buy the asset). The price of the contract is 5 million bushels at $3.50 per bushel.
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B.Types of Futures contracts Underlying assets
Depending on the type of underlying asset, there are different types of futures contract
available for trading. They are
Individual stock futures.
Stock index futures.
Commodity futures.
Currency futures.
Interest rate futures.
A. INDIVIDUAL STOCK FUTURES
Individual stock futures are the simplest of all derivative instruments.
B. STOCK INDEX FUTURES.
Understanding stock index futures is quite simple if you have understood individual stock
futures. Here the underlying asset is the stock index. For example the S&P CNX Niftypopularly called the nifty futures. Stock index futures are more useful when speculating
on the general direction of the market rather than the direction of a particular stock. It can
also be used to hedge and protect a portfolio of shares. So here, the price movement of
an index is tracked and speculated. One more point to note here is that, although stock
index is traded as an asset, it cannot be delivered to a buyer. Hence, it is always cash
settled.
Both individual stock futures and index futures are traded in the NSE.
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C. COMMODITY FUTURES
Its the same as individual stock futures. The underlying asset however would be a
commodity like gold or silver. In India, Commodity futures are mainly traded in two
exchanges1. MCX (Multi commodity exchange) and NCDEX (National commodities
and derivatives exchange). Unlike stock market futures where a lot of parameters are
measured, the commodity market is predominantly driven by demand and supply.
The term commodity is a very broad term and it includes
Bulliongold and silver
MetalsAluminum , copper, lead, iron, steel, nickel, tin, zinc
Energy-crude oil, gasoline, heating oil, electricity, natural gas
Weather- carbon
Oil and oil seedscrude palm oil, kapsica khali,refined Soya oil, Soya bean Cereals- barley, wheat, maize
Fiber- cotton, kapas
Species-cardamom, coriander, termuric etc
Pluseschana
Others- like potatoes, sugar, almonds, gaur
D. CURRENCY FUTURES.
The MCX-SX exchange trades the following currency futures:
Euro-Indian Rupee (EURINR),
Us dollar-Indian rupee (USDINR),
Pound Sterling-Indian Rupee (GBPINR) and
Japanese Yen-Indian Rupee (JPYINR).
E. INTEREST RATE FUTURES.
Interest rate futures are traded on the NSC. These are futures based on interest rates. In
India, interest rates futures were introduced on August 31, 2009.The logic of underlyingasset is the same as we saw in commodity or stock futuresin this case , the underlying
asset would be a debt obligationdebts that move in value according to changes in
interest rates (generally government bonds). Companies, banks, foreign institutional
investors, non-resident Indian and retail investors can trade in interest rate
futures. Buying an interest rate futures contract will allow the buyer to lock in a future
investment rate.
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FROM WEATHER TO TERROR..!!
Weather influences everyones lives. Right from daily lives to agriculture to corporate
earningseverything gets affected if the weather is not favorable. For examplelets
assume that this year cold winter is expected in most parts of the United States. What
happens is that the price of heating oil goes up. Heating oil futures are traded in
commodity markets depending on weather forecasts.
The fear of terrorist strikes had even made Pentagon think of creating a futures market to
help predict terrorist strikes. Their theory was that possibility of terror strikes in a
particular areafor example possibility of a terror strike in New York would be traded as
if it was a commodity. Higher the price, higher the possibilities of a terror strike. This
way they thought, would help them in finding potential threats.
Or take another examplethe assassination of Israel prime minister futures whichwould be available for trade as a commodity. Higher the price, the more likely the event.
1. Derivatives - Futures vs. Forwards
Futures differ from forwards in several instances:
A.
A forward contract is a private transaction - a futures contract is not. Futures
contracts are reported to the future's exchange, the clearing house and at least one
regulatory agency. The price is recorded and available from pricing services.
B. A future takes place on an organized exchange where the all of the contract's
terms and conditions, except price, are formalized. Forwards are customized to
meet the user's special needs. The future's standardization helps to create liquidity
in the marketplace enabling participants to close out positions before expiration.
C. Forwards have credit risk, but futures do not because a clearing house guarantees
against default risk by taking both sides of the trade and marking to market theirpositions every night. Mark to market is the process of converting daily gains and
losses into actual cash gains and losses each night. As one party loses on the trade
the other party gains, and the clearing house moves the payments for the
counterparty through this process.
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D. Forwards are basically unregulated, while future contract are regulated at the
federal government level. The regulation is there to ensure that no manipulation
occurs, that trades are reported in a timely manner and that the professionals in
the market are qualified and honest.
2. Characteristics of Futures Contracts
In a futures contract there are two parties:
A. The long position, or buyer, agrees to purchase the underlying at a later date or at
the expiration date at a price that is agreed to at the beginning of the transaction.
Buyers benefit from price increases.
B. The short position, or seller, agrees to sell the underlying at a later date or at the
expiration date at a price that is agreed to at the beginning of the transaction.
Sellers benefit from price decreases.
Prices change daily in the marketplace and are marked to market on a daily basis.
At expiration, the buyer takes delivery of the underlying from the seller or the parties can
agree to make a cash settlement.
C.
Initial Margin in Major Futures Exchanges
The percentage of the purchase price of securities (that can be purchased on
margin) that the investor must pay for with his or her own cash or marginable
securities.
Also called the "initial margin requirement."
In the futures market,margin has a definition distinct from its definition in the stock
market, where margin is the use of borrowed money to purchase securities. In the futures
market, margin refers to the initial deposit of "good faith"made into an account in order
to enter into a futures contract. This margin is referred to as good faith because it is this
money that is used to debit any day-to-day losses.
When you open a futures contract, the futures exchange will state a minimum amount of
money that you must deposit into your account.
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This original deposit of money is called theinitial margin.When your contract is
liquidated,you will be refunded the initial margin plus or minus any gains or losses that
occur over the span of the futures contract. In other words, the amount in your margin
account changes daily as the market fluctuates in relation to your futures contract. The
minimum-level margin is determined by the futures exchange and is usually 5% to 10%
of the futures contract. These predetermined initial margin amounts are continuously
under review: at times of high market volatility, initial margin requirements can be
raised.
The initial margin is the minimum amount required to enter into a new futures contract,
but themaintenance margin is the lowest amount an account can reach before needing to
be replenished. For example, if your margin account drops to a certain level because of a
series of daily losses, brokers are required to make amargin call and request that youmake an additional deposit into your account to bring the margin back up to the initial
amount.
Let's say that you had to deposit an initial margin of $1,000 on a contract and the
maintenance margin level is $500. A series of losses dropped the value of your account to
$400. This would then prompt the broker to make a margin call to you, requesting a
deposit of at least an additional $600 to bring the account back up to the initial margin
level of $1,000.
Word to the wise: when a margin call is made, the funds usually have to be delivered
immediately. If they are not, the brokerage can have the right to liquidate your position
completely in order to make up for any losses it may have incurred on your behalf.
Leverage: The Double-Edged Sword
In the futures market,leverage refers to having control over large cash amounts of
commodities with comparatively small levels of capital. In other words, with a relatively
small amount of cash, you can enter into a futures contract that is worth much more thanyou initially have to pay (deposit into your margin account). It is said that in the futures
market, more than any other form of investment, price changes are highly leveraged,
meaning a small change in a futures price can translate into a huge gain or loss.
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Futures positions are highly leveraged because the initial margins that are set by the
exchanges are relatively small compared to the cash value of the contracts in question
(which is part of the reason why the futures market is useful but also very risky). The
smaller the margin in relation to the cash value of the futures contract, the higher the
leverage. So for an initial margin of $5,000, you may be able to enter into a long position
in a futures contract for 30,000 pounds of coffee valued at $50,000, which would be
considered highly leveraged investments.
You already know that the futures market can be extremely risky and, therefore, not for
the faint of heart. This should become more obvious once you understand the arithmetic
of leverage. Highly leveraged investments can produce two results: great profits or
greater losses.As a result of leverage, if the price of the futures contract moves up even slightly, the
profit gain will be large in comparison to the initial margin. However, if the price just
inches downwards, that same high leverage will yield huge losses in comparison to the
initial margin deposit. For example, say that in anticipation of a rise in stock prices across
the board, you buy a futures contract with a margin deposit of $10,000, for an index
currently standing at 1300. The value of the contract is worth $250 times the index (e.g.
$250 x 1300 = $325,000), meaning that for every point gain or loss, $250 will be gained
or lost.
If after a couple of months, the index realized a gain of 5%, this would mean the index
gained 65 points to stand at 1365. In terms of money, this would mean that you as an
investor earned a profit of $16,250 (65 points x $250); a profit of 162%!
On the other hand, if the index declined 5%, it would result in a monetary loss of $16,250
- a huge amount compared to the initial margin deposit made to obtain the contract. This
means you still have to pay $6,250 out of your pocket to cover your losses. The fact that a
small change of 5% to the index could result in such a large profit or loss to the investor(sometimes even more than the initial investment made) is the risky arithmetic of
leverage. Consequently, while the value of a commodity or a financial instrument may
not exhibit very much price volatility, the same percentage gains and losses are much
more dramatic in futures contracts due to low margins and high leverage.
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Pricing and Limits
contracts in the futures market are a result of competitive price discovery. Prices are
quoted, as they would be in the cash market: in dollars and cents or per unit (gold ounces,
bushels, barrels, index points, percentages and so on).
Prices on futures contracts, however, have a minimum amount that they can move. These
minimums are established by the futures exchanges and are known as "ticks." For
example, the minimum sum that a bushel of grain can move upwards or downwards is a
quarter of one U.S. cent. For futures investors, it's important to understand how the
minimum price movement for each commodity will affect the size of the contract inquestion. If you had a wheat contract for 5,000 bushels, the minimum price movement
would be $12.50 ($0.0025 x 5,000).
Futures prices also have a price change limit that determines the prices between which
the contracts can trade on a daily basis. The price change limit is added to and subtracted
from the previous day's close and the results remain the upper and lower price boundary
for the day.
Say that the price change limit on silver per ounce is $0.25. Yesterday, the price per
ounce closed at $5. Today's upper price boundary for silver would be $5.25 and the lower
boundary would be $4.75. If at any moment during the day the price of futures contracts
for silver reaches either boundary, the exchange shuts down all trading of silver futures
for the day. The next day, the new boundaries are again calculated by adding and
subtracting $0.25 to the previous day's close. Each day the silver ounce could increase or
decrease by $0.25 until an equilibrium price is found. Because trading shuts down if
prices reach their daily limits, there may be occasions when it is NOT possible to
liquidate an existing futures position at will.
The exchange can revise this price limit if it feels it's necessary. It's not uncommon for
the exchange to abolish daily price limits in the month that the contract expires (delivery
or "spot"month). This is because trading is often volatile during this month, as sellers
and buyers try to obtain the best price possible before the expiration of the contract.
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In order to avoid any unfair advantages, the CTFC and the futures exchanges impose
limits on the total amount of contracts or units of a commodity in which any single
person can invest. These are known as position limits and they ensure that no one person
can control the market price for a particular commodity.
Commodity Futures
Product
Client Margin Clearing HouseMargin
Initial Maintenance
(US$) (US$) (US$)
Gold Futures Full Rate 4,810 3,850 3,850
(/lot)
Spread Rate 1,450 1,160 1,160
(/spread)
Currency Futures
Product
Client Margin Clearing HouseMargin
Initial Maintenance
(RMB) (RMB) (RMB)USD/CNH Futures Full Rate 15,510 12,410 12,410
(/lot)
Spread Rate 9,310 7,450 7,450
(/spread)
Spot Month Charge 3,110 2,490 2,490
(/lot)
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Index Futures
Product
Client Margin Clearing HouseMargin
Initial Maintenance
(HK$) (HK$) (HK$)
Hang Seng Index Futures Full Rate 93,750 75,000 75,000
(/lot)
Spread Rate 18,750 15,000 15,000
(/spread)
Mini-Hang Seng Index Futures Full Rate 18,750 15,000 15,000
(/lot)
Spread Rate 3,750 3,000 3,000
(/spread)
H-share Index Futures Full Rate 41,250 33,000 32,950
(/lot)
Spread Rate 12,400 9,900 9,900
(/spread)
Mini-H-share Index Futures Full Rate 8,250 6,600 6,590
(/lot)
Spread Rate 2,480 1,980 1,980
(/spread)
CES China 120 Index Futures Full Rate 12,930 10,340 10,340
(/lot)
Spread Rate 3,880 3,110 3,110
(/spread)
HSCEI Dividend Point Index Futures Full Rate 2,230 1,780 1,780
(/lot)
Spread Rate 2,680 2,140 2,140
(/spread)
HSI Dividend Point Index Futures Full Rate 4,570 3,650 3,650
(/lot)
Spread Rate 5,490 4,380 4,380
(/spread)
HSI Volatility Index Futures Full Rate 24,660 19,730 19,730
(/lot)
Spread Rate 7,400 5,920 5,920
(/spread)
IBOVESPA Futures Full Rate 18,690 14,950 14,950
(/lot)
Spread Rate 5,610 4,490 4,490
(/spread)
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S&P BSE Sensex Index Futures Full Rate 16,510 13,210 13,210
(/lot)
Spread Rate 4,960 3,970 3,970
(/spread)
FTSE/JSE Top40 Futures Full Rate 28,970 23,180 23,180
(/lot)
Spread Rate 8,700 6,960 6,960
(/spread)
MICEX Index Futures Full Rate 16,390 13,110 13,110
(/lot)
Spread Rate 4,920 3,940 3,940
(/spread)
Interest Rate Futures
Product
Client Margin Clearing HouseMargin
Initial Maintenance
(HK$) (HK$) (HK$)
Three-year Exchange Fund Note (EFN)Futures
Full Rate 11,350 9,080 8,570
(/lot)
Spread Rate 3,410 2,730 2,580
(/spread)
One-Month HIBOR Futures Full Rate 272 217 207
(/lot)
Three-Month HIBOR Futures Full Rate 1,030 822 779
(/lot)
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Stock Futures
Product
Client Margin Clearing HouseMargin
Initial Maintenance
(HK$) (HK$) (HK$)
iShares FTSE A50 China Index ETF Futures Full Rate 2,840 2,270 2,270
(/lot)
Spread Rate 852 681 681
(/spread)
Aluminum Corporation of China Ltd. Futures Full Rate 822 658 621
(/lot)
Spread Rate 247 198 187
(/spread)
China AMC CSI 300 index ETF Futures Full Rate 3,760 3,010 3,010
(/lot)
Spread Rate 1,130 903 903
(/spread)
Bank of China Ltd. Futures Full Rate 229 183 183
(/lot)
Spread Rate 69 55 55
(/spread)
Bank of Communications Co. Ltd. Futures Full Rate 355 284 284
(/lot)
Spread Rate 107 86 86
(/spread)
The Bank of East Asia Limited Futures Full Rate 420 336 336
(/lot)
Spread Rate 126 101 101
(/spread)
BOC Hong Kong (Holdings) Ltd. Futures Full Rate 807 645 645
(/lot)
Spread Rate 243 194 194
(/spread)
China Construction Bank Corporation Futures Full Rate 366 293 293
(/lot)
Spread Rate 110 88 88
(/spread)
China Communications Construction Co.Limited Futures
Full Rate 373 298 298
(/lot)
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Spread Rate 112 90 90
(/spread)
China Mobile Limited Futures Full Rate 3,620 2,900 2,750
(/lot)
Spread Rate 1,090 870 825
(/spread)
China Unicom (Hong Kong) Limited Futures Full Rate 2,070 1,660 1,570
(/lot)
Spread Rate 621 498 471
(/spread)
CITIC Limited Futures Full Rate 1,230 984 921
(/lot)
Spread Rate 369 296 277
(/spread)
Cheung Kong (Holdings) Limited Futures
(CKH - Multiplier = 1,000)
Full Rate 9,190 7,360 7,350
(/lot)
Spread Rate 2,760 2,210 2,210
(/spread)
Cheung Kong (Holdings) Limited Futures(CKA - Multiplier = 1,055)
Full Rate 9,697 7,766 7,756
(/lot)
Spread Rate 2,912 2,332 2,332
(/spread)
China Life Insurance Co. Ltd. Futures Full Rate 1,430 1,150 1,140
(/lot)
Spread Rate 429 345 342
(/spread)
CLP Holdings Limited Futures Full Rate 2,100 1,680 1,680
(/lot)
Spread Rate 630 504 504
(/spread)
China Merchants Bank Co. Ltd. Futures Full Rate 474 379 379
(/lot)
Spread Rate 143 114 114
(/spread)
CNOOC Limited Futures Full Rate 933 746 746
(/lot)
Spread Rate 280 224 224
(/spread)
Cathay Pacific Airways Limited Futures Full Rate 933 747 747
(/lot)
Spread Rate 280 225 225
(/spread)
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China Petroleum & Chemical CorporationFutures
Full Rate 938 750 750
(/lot)
Spread Rate 282 225 225
(/spread)
CSOP FTSE China A50 ETF Futures Full Rate 2,960 2,370 2,370
(/lot)
Spread Rate 888 711 711
(/spread)
China Telecom Corporation Ltd. Futures Full Rate 587 470 446
(/lot)
Spread Rate 177 141 134
(/spread)
Esprit Holdings Limited Futures Full Rate 79 63 63
(/lot)
Spread Rate 24 19 19
(/spread)
FIH Mobile Limited Futures Full Rate 362 290 272
(/lot)
Spread Rate 109 87 82
(/spread)
Power Assets Holdings Limited Futures Full Rate 2,310 1,850 1,850
(/lot)
Spread Rate 693 555 555
(/spread)
Hong Kong Exchanges and Clearing Limited
Futures
Full Rate 1,150 913 913
(/lot)
Spread Rate 345 274 274
(/spread)
HSBC Holdings Plc. Futures Full Rate 2,070 1,650 1,650
(/lot)
Spread Rate 621 495 495
(/spread)
The Hong Kong and China Gas CompanyLimited Futures (HKG - Multiplier = 1,000)
Full Rate 1,130 904 904
(/lot)
Spread Rate 339 272 272
(/spread)
The Hong Kong and China Gas CompanyLimited Futures (HKE - Multiplier = 1,100)
Full Rate 1,243 994 994
(/lot)
Spread Rate 373 299 299
(/spread)
Henderson Land Development CompanyLimited Futures (HLD - Multiplier = 1,000)
Full Rate 3,380 2,710 2,580
(/lot)
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Spread Rate 1,020 813 774
(/spread)
Henderson Land Development CompanyLimited Futures (HLB - Multiplier = 1,100)
Full Rate 3,718 2,981 2,838
(/lot)
Spread Rate 1,122 894 851
(/spread)
Huaneng Power International, Inc. Futures Full Rate 1,350 1,080 1,010
(/lot)
Spread Rate 405 324 303
(/spread)
Hang Seng Bank Limited Futures Full Rate 828 662 662
(/lot)
Spread Rate 249 199 199
(/spread)
Hutchison Whampoa Limited Futures (HWL -
Multiplier = 1,000)
Full Rate 6,520 5,220 5,220
(/lot)
Spread Rate 1,960 1,570 1,570
(/spread)
Hutchison Whampoa Limited Futures (HWA -Multiplier = 1,069)
Full Rate 6,972 5,582 5,582
(/lot)
Spread Rate 2,096 1,679 1,679
(/spread)
Industrial and Commercial Bank of China Ltd.Futures
Full Rate 325 260 260
(/lot)
Spread Rate 98 78 78
(/spread)
Li & Fung Limited Futures (LIF - Multiplier =2,000)
Full Rate 1,290 1,030 1,030
(/lot)
Spread Rate 387 309 309
(/spread)
Li & Fung Limited Futures (LIB - Multiplier =2,392)
Full Rate 1,543 1,232 1,232
(/lot)
Spread Rate 463 370 370
(/spread)
MTR Corporation Limited Futures Full Rate 973 778 778
(/lot)
Spread Rate 292 234 234
(/spread)
New World Development Co. Ltd. Futures(NWD - Multiplier = 1,000)
Full Rate 617 493 493
(/lot)
Spread Rate 186 148 148
(/spread)
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New World Development Co. Ltd. Futures(NWA - Multiplier = 1,062)
Full Rate 655 524 524
(/lot)
Spread Rate 198 157 157
(/spread)
Ping An Insurance (Group) Co. of China Ltd.
Futures
Full Rate 2,010 1,610 1,610
(/lot)
Spread Rate 603 483 483
(/spread)
PetroChina Company Limited Futures Full Rate 1,330 1,070 1,070
(/lot)
Spread Rate 399 321 321
(/spread)
PICC Property and Casualty Co. LimitedFutures
Full Rate 1,640 1,310 1,240
(/lot)
Spread Rate 492 393 372
(/spread)
Sun Hung Kai Properties Limited Futures(SHKMultiplier = 1,000)
Full Rate 7,290 5,840 5,840
(/lot)
Spread Rate 2,190 1,760 1,760
(/spread)
Sun Hung Kai Properties Limited Futures(SKAMultiplier = 1,007)
Full Rate 7,338 5,878 5,878
(/lot)
Spread Rate 2,204 1,772 1,772
(/spread)
Swire Pacific Limited "A" Shares Futures Full Rate 3,240 2,590 2,590
(/lot)
Spread Rate 972 777 777
(/spread)
The Wharf (Holdings) Ltd. Futures Full Rate 3,860 3,090 3,050
(/lot)
Spread Rate 1,160 927 915
(/spread)