Futures (SAPM)

7/31/2019 Futures (SAPM)

1/25

Chapter 19

FUTURES

Where the Hedgers and the

Speculators Meet


2/25

OUTLINE

Features of a Futures Contract

Mechanics of Trading

Futures Contracts : The Global Scene

Financial Futures

Equity Futures in India

Pricing of Futures Contracts

Use of Futures Contracts

Assessment


3/25

WHAT IS A FUTURES CONTRACT?

A forward contract is an agreement between two parties to

exchange an asset for cash at a predetermined future date

for a price that is specified today. A futures contract is a

standardised forward contract.


4/25


5/25

FUTURES TERMINOLOGY

SPOT PRICE

FUTURES PRICE

CONTRACT CYCLE

EXPIRY DATE

CONTRACT SIZETHE AMOUNT OF ASSET THAT HAS TO BE DELIVEREDUNDER ONE CONTRACT. FOR INSTANCE, THE CONTRACTSIZE ON NSES FUTURES IS 200 NIFTIES

BASIS

FUTURES PRICE - SPOT PRICE

INITIAL MARGIN

MARKING TO MARKET

MAINTENANCE MARGIN


6/25

PAYOFFS TO THE FORWARD BUYER AND

FORWARD SELLER

A : Forward Buyer B : Forward SellerProfit Profit

Loss Loss

C

C

P

P

C = Contract price

P = Actual price


7/25

MECHANICS OF TRADING

Trading in futures is more complex than trading in stocks.Inter alia it involves

Intermediation by a clearing house

Margins

Marking - to - market


8/25

Longposition

Money

Clearinghouse

Shortposition

Asset

Money

Asset

THE ROLE OF THE CLEARING HOUSE


9/25

MARGINS

When you execute a futures trade, you have to providethe initial margin.

If you incur sustained losses from daily marking-to-market, and your margin amount falls below a critical

level called the maintenance margin you have to

replenish the margin amount.


10/25

MARKING-TO-MARKET

While forward contracts are settled on the maturity date, futures

contracts are marked to market on a periodic basis.

Assume that the spot price of gold is $450 and the four period

futures contract in gold has a price of $460. In the wake of changes

in the price of the gold futures contract, the cash flow to the buyer

and seller of this contract will be as shown in the last two columns of

the following table.

Gold Forward Futures

Time Period Futures contract Buyers cash flow Sellers cash flow Buyers cashflow Sellers cash flow

1 465 $0 0 $5 $-52 455 0 0 -10 103 460 0 0 5 -54 465 5 -5 5 -5


11/25

FUTURES CONTRACTS GLOBAL SCENE

Commodity Futures Exchange Financial Futures Exchange

Cocoa CSCE, FOX U.S Treasury bills IMM, MCECotton CTN Eurodollar deposits IMM, LIFFEAluminum COMEX,LME Standard & Poor'sGold LME (S&P) Index IMMCrude oil IPE, NYMEX Sterling IMM, LIFFE,MCESoyabean oil CBT Phil SE

CSCE Coffee , Sugar and Cocoa Exchange , New YorkFOX London Futures and Options ExchangeCTN New York Cotton ExchangeCOMEX Commodity Exchange , New YorkLME London Metal ExchangeIPE International Petroleum Exchange of London

NYMEX New York Mercantile ExchangeCBT Chicago Board of TradeIMM International Monetary Market(at the Chicago Mercantile Exchange)LIFFE London International Financial Futures ExchangeMCE Mid America Commodity ExchangePhil SE Philadelphia stock Exchange


12/25

MAJOR TYPES OF FUTURES CONTRACTS

Type Example

Futures contracts on debt instruments US Treasury bond futures contract: Thisis a contract for delivery of US Treasurybonds with $100,000 face value andhaving a maturity of at least 15 yearfrom the delivery date

Futures contract on monetary metals Futures contract on gold: This is a

contract for delivery of 100 troy ouncesof gold of 0.995 fineness

Futures contract on foreign currencies Futures contract on British pound: Thisis a contract for delivery of 25,000 Britishpounds, on the appropriate future date

Futures contract on stock marketsindices Futures contract on S&P 500: The

underlying value of the contract is $500 times the S &P 500 index. Unlike other futures contracts, thesettlement of an index futures contract is by cashpayment


13/25

FINANCIAL FUTURES

Equity Futures

Interest Rate Futures

Foreign Exchange Futures

j


14/25

j

STOCK INDEX FUTURES

S & P CNX NIFTY FUTURES

TRADING CYCLE MAXIMUM OF 3 MONTHS

EXPIRY DAY LAST THURSDAY OF THE

EXPIRY MONTH


15/25

INDIVIDUAL STOCK FUTURES

TRADING CYCLE MAXIMUM 3 MONTHS

EXPIRY LAST THURSDAY OF THEEXPIRY MONTH

SIZE SAME AS THE LOT SIZE OF

OPTIONS CONTRACT FOR AGIVEN UNDERLYING

BASE PRICE ON INTRODUCTION, THE

PREVIOUS DAYS CLOSING

PRICE OF THE UNDERLYINGSECURITY

SETTLEMENT CASH-SETTLED. DAILY MARK-

TO-MARKET


16/25

PRICING OF EQUITY FUTURES

COST-OF-CARRY RELATIONSHIP

F0 = S0 (1 +rf)T

S0 = RS. 400 rf = 1% PER MONTH 3 MONTHS

FUTURES CONTRACT

F0 = S0 (1 +rf)T= 400 (1.01)3 = 412.12

SUPPOSE 3-MONTHS FUTURES RS. 412

ACTION INITIAL CASH FLOW CASH FLOW AT (3 MONTHS)

BORROW RS.400 + 400 - 400 (1.01)3 = - 412.12

NOW & REPAY

WITH INT. AT TIME T

BUY A SHARE - 400 ST

SELL A FUTURES 0 414 - ST

CONTRACT (F0 = RS. 414)0 RS. 1.88


17/25

PRICING OF EQUITY FUTURES2

F0 = S0 erft

WHEN THE UNDERLYING ASSET PRODUCES

INCOME TO THE OWNER

F0 = S0 (1 +rf -d)T

SUPPOSE STOCK INDEX S0 = 1200

rf

= 1% P.M

d = 0.25% P.M

F0 = 1200 (1 + 0.0075)3 = 1227.2


18/25

PRICING OF TREASURY BOND FUTURES

A TREASURY BOND FUTURES CONTRACT IS ACONTRACT FOR DELIVERY IN FUTURE OF

TREASURY BONDS HAVING CERTAIN FUTURES.

TREASURY BOND FEATURES ARE VALUED THEWAY STOCK INDEX FUTURES ARE VALUED, WITH

ONE DIFFERENCE.

F0 = (S0 -PVC) (1 +rf)T


19/25

PRICING OF COMMODITY FUTURES

(STORABLE COMMODITIES)

FUTURES SPOT PV OF PV OF

PRICE PRICE STORAGE CONVENIENCE

= + COSTS - YIELD

(1 +rf)T

S A CO O S


20/25

PERI SHABLE COMMODITIES

FUTURES PRICES VS. EXPECTED SPOT PRICES

SO FAR .. RELN FUTURES PRICES & CURRENT SPOT PRICE

A CONTROVERSY .. THEORY OF FUTURES PRICING CONCERNS .. RELN ..FUTURES PRICE & THE EXPECTED VALUE .. SPOT PRICE IN FUTURE

EXPECTNS

HYPOTHESIS : F = E (St)

NORMAL

BACKWARDN : F < E (St ) SUPPLIERS HEDGE

CONTANGO : F > E (St ) BUYERS HEDGE

FUTURES PRICES

CONTANGO

EXPECTNS HYPOTHES

NORMAL BACKWARDN

TIME

DELIVERY DATA


21/25

WHO USES FUTURES CONTRACTS?

Hedgers

Short (sell) hedge

Long (buy) hedge

Speculators

Arbitrageurs

Futures-futures arbitrage

Cash-futures arbitrage

WHAT ECONOMIC FUNCTIONS DO FUTURES AND


22/25

WHAT ECONOMIC FUNCTIONS DO FUTURES AND

OPTIONS PERFORM?

ECONOMIC FUNCTIONS

RISK TRANSFER PRICE DISCOVERY

MARKET COMPLETION LOWER VOLATILITY

HIGHER LIQUIDITY

LOWER TRANSACTION COSTS

EMPIRICAL EVIDENCE

CONCLUSION

DERIVATIVES .. SHIFT .. SUPPLY CURVE OF INVESTMENTCAPITAL DOWN AND TO THE RIGHT

DERIVATIVE MARKETS .. TRUE CHILD OF THE FINANCIAL &INFORMATION SERVICES REVOLN LEADING EDGE ..GLOBAL INTEGRATION OF FINANCE

RICHARD O BRIEN


23/25

CRITIQUE AND RESPONSE

NOTWITHSTANDING ENDORSEMENT OF DERIVATIVES ..

BY FINANCIAL ECONOMISTS AND BUSINESS PERSONS

WIDESPREAD CONCERN .. JOHN SHAD

FUTURES AND OPTIONS ARE THE TAIL WAGGING THE

DOG. THEY HAVE ESCALATED THE LEVERAGE AND

VOLATILITY OF THE MARKETS TO PRECIPITOUS,UNACCEPTABLE LEVELS

MANY IN THE PROFESSION DISAGREE

VOLATILITY IN THE UNDERLYING CASH MARKET IS THE

IMPETUS FOR INTRODUCING DERIVATIVES AND NOT THECONSEQUENCE THEREOF

EMPIRICAL EVIDENCE DECLINE .. IN .. VOLATILITY OF ..

UNDERLYING .. CASH MARKET INTRN OF DERIVATIVES

SUMMING UP


24/25

SUMMING UP

A standardised forward contract is a futures contract.

Broadly, there are two types of futures, commodity futures and

financial futures.

The three main types of financial futures are: equity futures,treasury bond (or interest rate) futures, and currency futures.

Equity futures are of two types: stock index futures and futures onindividual securities. Both the types of futures have beenintroduced in India.

A treasury bond futures contract is a contract for delivery infuture of treasury bonds having certain features.

Futures contracts can be priced using the principle of arbitrage.

The theoretical price of the stock index futures, as well as futureson an individual stock, is:

F0 = S0 (1 +rfd)T


25/25

Documents

Futures (SAPM)