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A. Futures contract
A. Definition
a futures contract (more colloquially, futures) is a standardized contract between 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, making it a type of derivative instrument. The contracts are
negotiated 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, 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), the margin.
Additionally, since the 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 the spot value (i.e. the original
value agreed upon, since any gain or loss has already been previously settled by marking
to market).
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.
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.
Let's assume that in September the spot or current price for hydroponic tomatoes is $3.25
per 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 to
determine how much to charge for a Big Mac next year. The farmer and the corporation
can enter into a futures contract requiring the delivery of 5 million bushels of tomatoes to
McDonald's in December at a price of $3.50 per bushel. The contract locks in a price for
both parties. It is this contract - and not the grain per se - that can then be bought and sold
in the futures market.
In this scenario, the farmer is the holder of the short position (he has agreed to sell the
underlying asset - tomatoes) and McDonald's is the holder of the long position (it has
agreed to buy the asset). The price of the contract is 5 million bushels at $3.50 per bushel.
Depending on the type of underlying asset, there are different types of futures contract
available for trading. They are
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
exchanges 1. 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
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 underlying
asset is the same as we saw in commodity or stock futures in this case , the underlying
asset would be a debt obligation debts 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.
5
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.
This original deposit of money is called the initial 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 the maintenance 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 a margin call and request that you
make 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 than
you 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.
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 $6,250 out of your pocket to cover your losses. The fact that a
small change of 5% to the index could result in such a large profit or loss to the investor
(sometimes even more than the initial investment made) is the risky arithmetic of
leverage. Consequently, while the value of a commodity or a financial instrument may
not exhibit very much price volatility, the same percentage gains and losses are much
more dramatic in futures contracts due to low margins and high leverage.
10
In order to avoid any unfair advantages, the CTFC and the futures exchanges impose
limits on the total amount of contracts or units of a commodity in which any single
person can invest. These are known as position limits and they ensure that no one person
can control the market price for a particular commodity.
Commodity Futures
Client Margin
Product
Gold Futures
Full Rate
Clearing House
Margin
Initial
Maintenance
(US$)
(US$)
(US$)
4,810
3,850
3,850
1,450
1,160
1,160
(/lot)
Spread Rate
(/spread)
Currency Futures
Client Margin
Product
USD/CNH Futures
Full Rate
Clearing House
Margin
Initial
Maintenance
(RMB)
(RMB)
(RMB)
15,510
12,410
12,410
9,310
7,450
7,450
3,110
2,490
2,490
(/lot)
Spread Rate
(/spread)
Spot Month Charge
(/lot)
11
Index Futures
Client Margin
Product
Hang Seng Index Futures
Full Rate
Clearing House
Margin
Initial
Maintenance
(HK$)
(HK$)
(HK$)
93,750
75,000
75,000
18,750
15,000
15,000
18,750
15,000
15,000
3,750
3,000
3,000
41,250
33,000
32,950
12,400
9,900
9,900
8,250
6,600
6,590
2,480
1,980
1,980
12,930
10,340
10,340
3,880
3,110
3,110
2,230
1,780
1,780
2,680
2,140
2,140
4,570
3,650
3,650
5,490
4,380
4,380
24,660
19,730
19,730
7,400
5,920
5,920
18,690
14,950
14,950
5,610
4,490
4,490
(/lot)
Spread Rate
(/spread)
Mini-Hang Seng Index Futures
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
IBOVESPA Futures
Full Rate
(/lot)
Spread Rate
(/spread)
12
Full Rate
16,510
13,210
13,210
4,960
3,970
3,970
28,970
23,180
23,180
8,700
6,960
6,960
16,390
13,110
13,110
4,920
3,940
3,940
(/lot)
Spread Rate
(/spread)
FTSE/JSE Top40 Futures
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Clearing House
Margin
Initial
Maintenance
(HK$)
(HK$)
(HK$)
11,350
9,080
8,570
3,410
2,730
2,580
272
217
207
1,030
822
779
Product
Three-year Exchange Fund Note (EFN)
Futures
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Full Rate
(/lot)
13
Stock Futures
Client Margin
Clearing House
Margin
Initial
Maintenance
(HK$)
(HK$)
(HK$)
2,840
2,270
2,270
852
681
681
822
658
621
247
198
187
3,760
3,010
3,010
1,130
903
903
229
183
183
69
55
55
355
284
284
107
86
86
420
336
336
126
101
101
807
645
645
243
194
194
366
293
293
110
88
88
373
298
298
Product
iShares FTSE A50 China Index ETF Futures
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
14
Spread Rate
112
90
90
3,620
2,900
2,750
1,090
870
825
2,070
1,660
1,570
621
498
471
1,230
984
921
369
296
277
9,190
7,360
7,350
2,760
2,210
2,210
9,697
7,766
7,756
2,912
2,332
2,332
1,430
1,150
1,140
429
345
342
2,100
1,680
1,680
630
504
504
474
379
379
143
114
114
933
746
746
280
224
224
933
747
747
280
225
225
(/spread)
China Mobile Limited Futures
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
15
Full Rate
938
750
750
282
225
225
2,960
2,370
2,370
888
711
711
587
470
446
177
141
134
79
63
63
24
19
19
362
290
272
109
87
82
2,310
1,850
1,850
693
555
555
1,150
913
913
345
274
274
2,070
1,650
1,650
621
495
495
1,130
904
904
339
272
272
1,243
994
994
373
299
299
3,380
2,710
2,580
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
16
Spread Rate
1,020
813
774
3,718
2,981
2,838
1,122
894
851
1,350
1,080
1,010
405
324
303
828
662
662
249
199
199
6,520
5,220
5,220
1,960
1,570
1,570
6,972
5,582
5,582
2,096
1,679
1,679
325
260
260
98
78
78
1,290
1,030
1,030
387
309
309
1,543
1,232
1,232
463
370
370
973
778
778
292
234
234
617
493
493
186
148
148
(/spread)
Henderson Land Development Company
Limited Futures (HLB - Multiplier = 1,100)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
17
Full Rate
655
524
524
198
157
157
2,010
1,610
1,610
603
483
483
1,330
1,070
1,070
399
321
321
1,640
1,310
1,240
492
393
372
7,290
5,840
5,840
2,190
1,760
1,760
7,338
5,878
5,878
2,204
1,772
1,772
3,240
2,590
2,590
972
777
777
3,860
3,090
3,050
1,160
927
915
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
Full Rate
(/lot)
Spread Rate
(/spread)
18