Hamutyinei Harvey Pamburai RM 4.67 Leslie Social Science Building

FTX3045S FINANCE 11
FUTURES MARKETS
2015
Hamutyinei Harvey Pamburai
Rm 4.67 Leslie Social Science Building
[email protected]
1
Learning Objectives
 Understand a distinction between futures and
forwards
 Understand how futures and forwards are traded
 Understand Futures contract specifications
 Understand how to interpret Newspaper quotes
 Understanding futures price
 Understand how futures contracts can be used as a
Hedging strategy
 Understand how futures contracts can be used for
Speculation
• Basis Risk
2
Futures v.s. Forwards
Forward contract – is an agreement between two
parties in which one party, the buyer agrees to buy
from the other party, the seller, an underlying
asset or other derivative, at a future date at a price
established at the start of the contract.
Futures contract - is an agreement between two
parties in which one party, the buyer agrees to buy
from the other party, the seller, an underlying
asset or other derivative, at a future date at a price
agreed on today.
3
Risk – Price movements
4
Forwards
o Not created in any specific location, i.e. they are not
exchange traded
o Traded between private parties over the counter (OTC) not
exchanged traded
• they are private contracts or agreements whose prices
are not reported in any news.
• traded in an informal market – established by a network
of banks and Brokers.
• no secondary market
• Illiquid
• Risky i.e high credit risk- there is no guarantee for
performance since there is no margin requirement.
o Not regulated
5
Forwards (continued)
o Contracts specifications are customised to meet the needs of
both parties.
• Parties to the forward contract establish all the terms of the
contract, i.e. identity of the underlying asset, expiration date,
the manner in which the contract is settled and the price.
o Held until maturity and no exchange of cash until delivery date,
i.e. they have only one settlement date.
o Pre-agreed price – Forward price
o Mostly used by hedgers who want to eliminate volatility of an
asset price
o Delivery of an asset or cash settlement usually takes place.
6
Futures
o Traded on organised exchange (e.g SAFEX, CBOT)
– they are a public transaction.
– Have a secondary market
– Liquid
o They follow a pay (or receive) as you go method
– Marking-to-market (Margin).
– Cash settlement on daily basis
o Pre-agreed price – Futures price (F0)
o Contracts are standardized
– Standardised terms, e.g. Grade, contract size,
delivery date etc… are known to all parties
– They are regulated at federal government level
7
Basics of Futures Contracts
• Positions:
 Long – commitment to buy the
underlying asset.
 Short – commitment to sell the

underlying asset.
• Unlike options, futures and forward
contracts are not “bought”.
8
Futures v.s. options
Futures contracts is a commitment

No need to distinguish between profit/loss to
payoff
9
Futures Traded
o Traded on four main categories:
• Agricultural commodities (corn, wheat…)
• Metals and minerals (gold, platinum…)
• Foreign currencies (Euro, Yen…)
• Financial Futures (indices and bonds)
Now also:
Energy and weather futures and options!
10
Eurex
o Origin of electronic trading

– Electronic trading has replaced most floor trading
o Jointly owned by Deutche Borse and
Swiss Exchange
o Currently, one of world’s largest
exchange on futures and options
11
12
13
14
Futures Specifications
Underlying asset
• Contract Size
 Amount of asset to be delivered per
contract
 Important decision for the exchange!
Delivery Arrangements
 Location (N.B. for commodities!
transportation costs)
 How they are delivered
15
Futures Specifications
• Delivery months
 Given timeframe for delivery (usually a month)
 E.g. Corn futures on CBOT – Mar, May, Jul, Sep, Dec
 Specifies last day of trade
• Price quotes (futures price)
• Price limits and Position limits
 Price limits: limit up / limit down (trading ceases for
the day)
 Position limits: maximum number of contract one
can hold
• Prevents speculators from excessive influence on
the market!
16
17
Newspaper
Quotes
18
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20
Trading process
21
Newspaper Quotes
• Expiry month?
• High and low?
• Contract size?
• Corn: 5000 bushels per contract
• Price Change?
• Open interests?
22
Open Interests
Number of futures contracts outstanding
• i.e. not closed or delivered on any particular day.
23
Profit / Loss
• Profit to Long = Spot Price@T – Original futures price
• Profit to short = Original futures price – Spot Price@T
• Futures contract is a “zero-sum game”

• Profit nets out to zero for all positions
• Hence, no major effect on spot price!
24
Margin Accounts
• Exchange overseen by Clearing house – uses
clearing margins as guarantee.
• Security Account consisting of cash or near-
cash securities (e.g. T-bill)
• Profit/loss accrued on daily basis according to
marking-to-market
• Initial margin: 5%-15%
25
Example: Gold Futures
Suppose:
Gold futures with F0 = $600.
100 ounce per contract (long 2 futures).
Initial margin $2000 per contract (i.e. $4000
required)
Excel illustration (time permitting).
26
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Delivery
Commodities:
Allowable grades (No. 2 hard winter wheat or No.
1 soft red wheat…etc)
Place and means (Transfer of warehouse receipt)
Index futures
Delivery takes form of cash settlement
Delivery rarely occurs!
28
Closing out positions
• Entering into the opposite position of trade

from original.
• Total gain (loss) determined by change in
futures price between initial date and close out
date.
• Delivery is unusual that trader sometimes
“forget” how the process works!
29
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FTX3045S FINANCE 11

Hamutyinei Harvey Pamburai

Rm 4.67 Leslie Social Science Building

 Short – commitment to sell the

Futures contracts is a commitment

o Origin of electronic trading

• Futures contract is a “zero-sum game”

• Entering into the opposite position of trade

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