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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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a.org/wiki/Jutehttp://en.wikipedia.org/wiki/Vegetable_fats_and_oilshttp://en.wikipedia.org/wiki/Mumbaihttp://en.wikipedia.org/wiki/Futures_contract#cite_note-timeline-of-achievements-2http://en.wikipedia.org/wiki/Commodityhttp://en.wikipedia.org/wiki/Grainhttp://en.wikipedia.org/wiki/Chicago_Board_of_Tradehttp://en.wikipedia.org/wiki/Futures_contract#cite_note-1http://en.wikipedia.org/wiki/Samuraihttp://en.wikipedia.org/wiki/D%C5%8Djima_Rice_Exchangehttp://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=1http://en.wikipedia.org/wiki/Futures_contract#External_linkshttp://en.wikipedia.org/wiki/Futures_contract#U.S._Futures_exchanges_and_regulatorshttp://en.wikipedia.org/wiki/Futures_contract#Referenceshttp://en.wikipedia.org/wiki/Futures_contract#Noteshttp://en.wikipedia.org/wiki/Futures_contract#See_alsohttp://en.wikipedia.org/wiki/Futures_contract#Further_readinghttp://en.wikipedia.org/wiki/Futures_contract#Margininghttp://en.wikipedia.org/wiki/Futures_contract#Exchange_versus_OTChttp://en.wikipedia.org/wiki/Futures_contract#Futures_versus_forwardshttp://en.wikipedia.org/wiki/Futures_contract#Definition_of_futures_contracthttp://en.wikipedia.org/wiki/Futures_contract#Futures_contract_regulationshttp://en.wikipedia.org/wiki/Futures_contract#Options_on_futureshttp://en.wikipedia.org/wiki/Futures_contract#Speculatorshttp://en.wikipedia.org/wiki/Futures_contract#Hedgershttp://en.wikipedia.org/wiki/Futures_contract#Who_trades_futures.3Fhttp://en.wikipedia.org/wiki/Futures_contract#Codeshttp://en.wikipedia.org/wiki/Futures_contract#Futures_contracts_and_exchangeshttp://en.wikipedia.org/wiki/Futures_contract#Contango_and_backwardation

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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

http://en.wikipedia.org/wiki/Backwardationhttp://en.wikipedia.org/wiki/Backwardationhttp://en.wikipedia.org/wiki/Backwardationhttp://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=9http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=9http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=9http://en.wikipedia.org/wiki/Single-stock_futureshttp://en.wikipedia.org/wiki/Single-stock_futureshttp://en.wikipedia.org/wiki/Single-stock_futureshttp://en.wikipedia.org/wiki/Commodity_marketshttp://en.wikipedia.org/wiki/Commodity_marketshttp://en.wikipedia.org/wiki/Commodity_marketshttp://en.wikipedia.org/wiki/Commodity_marketshttp://en.wikipedia.org/wiki/List_of_traded_commoditieshttp://en.wikipedia.org/wiki/List_of_traded_commoditieshttp://en.wikipedia.org/wiki/List_of_traded_commoditieshttp://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/Foreign_exchange_markethttp://en.wikipedia.org/wiki/Foreign_exchange_markethttp://en.wikipedia.org/wiki/Money_markethttp://en.wikipedia.org/wiki/Money_markethttp://en.wikipedia.org/wiki/Bond_markethttp://en.wikipedia.org/wiki/Bond_markethttp://en.wikipedia.org/wiki/Equity_derivative#Equity_futures.2C_options_and_swapshttp://en.wikipedia.org/wiki/Equity_derivative#Equity_futures.2C_options_and_swapshttp://en.wikipedia.org/wiki/Soft_Commodities_markethttp://en.wikipedia.org/wiki/Soft_Commodities_markethttp://en.wikipedia.org/wiki/Commodityhttp://en.wikipedia.org/wiki/Commodityhttp://en.wikipedia.org/wiki/Commodityhttp://en.wikipedia.org/wiki/Commodityhttp://en.wikipedia.org/wiki/Soft_Commodities_markethttp://en.wikipedia.org/wiki/Equity_derivative#Equity_futures.2C_options_and_swapshttp://en.wikipedia.org/wiki/Bond_markethttp://en.wikipedia.org/wiki/Money_markethttp://en.wikipedia.org/wiki/Foreign_exchange_markethttp://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/List_of_traded_commoditieshttp://en.wikipedia.org/wiki/Commodity_marketshttp://en.wikipedia.org/wiki/Commodity_marketshttp://en.wikipedia.org/wiki/Single-stock_futureshttp://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=9http://en.wikipedia.org/wiki/Backwardation

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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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http://en.wikipedia.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_Exchange

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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&section=11http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=11http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=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&section=12http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=12http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=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&section=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&section=11http://en.wikipedia.org/wiki/Futures_contract#cite_note-5

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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

http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=13http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=13http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=13http://en.wikipedia.org/wiki/Day_traderhttp://en.wikipedia.org/wiki/Day_traderhttp://en.wikipedia.org/wiki/Day_traderhttp://en.wikipedia.org/wiki/Day_traderhttp://en.wikipedia.org/wiki/Swing_tradinghttp://en.wikipedia.org/wiki/Swing_tradinghttp://en.wikipedia.org/wiki/Swing_tradinghttp://en.wikipedia.org/wiki/Futures_contract#cite_note-6http://en.wikipedia.org/wiki/Futures_contract#cite_note-6http://en.wikipedia.org/wiki/Futures_contract#cite_note-6http://en.wikipedia.org/wiki/Mutual_fundhttp://en.wikipedia.org/wiki/Mutual_fundhttp://en.wikipedia.org/wiki/Mutual_fundhttp://en.wikipedia.org/wiki/Separately_managed_accounthttp://en.wikipedia.org/wiki/Separately_managed_accounthttp://en.wikipedia.org/wiki/Separately_managed_accounthttp://en.wikipedia.org/wiki/Portfolio_managerhttp://en.wikipedia.org/wiki/Portfolio_managerhttp://en.wikipedia.org/wiki/Portfolio_managerhttp://en.wikipedia.org/wiki/Tracking_errorhttp://en.wikipedia.org/wiki/Tracking_errorhttp://en.wikipedia.org/wiki/Tracking_errorhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Time_preferencehttp://en.wikipedia.org/wiki/Time_preferencehttp://en.wikipedia.org/wiki/Time_preferencehttp://en.wikipedia.org/wiki/Wikipedia:Citation_neededhttp://en.wikipedia.org/wiki/Wikipedia:Citation_neededhttp://en.wikipedia.org/wiki/Wikipedia:Citation_neededhttp://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=14http://en.wikipedia.org/w/index.php?title=Futures_contract&action=edit&section=14http://en.wikipedia.org/w/index.php?title=