In financea futures contract more colloquially, futures is a standardized forward contract which can be easily traded between parties other than the two initial parties to the contract. The parties initially agree to buy and sell an asset for a price agreed upon today the forward pricewith delivery and payment occurring at a future point, the delivery date. Because it is a function of an underlying asset, a future contract is a derivative product. Contracts are negotiated at futures exchangeswhich act as a marketplace between buyers and sellers. The buyer of a contract is said to be long position holder, and the selling party is said to be short position holder. Financial futures were introduced inand in recent decades, currency futuresinterest wiki futures and stock market index futures have options an increasingly large role in the overall futures markets. The original use of futures contracts was to mitigate the risk of price or exchange rate movements by allowing parties to fix prices or rates in advance for future transactions. This could be advantageous when for example a party expects to receive payment in foreign currency in the future, and wishes to guard against an unfavorable movement of the currency in the interval before payment is received. However, futures contracts also offer opportunities for speculation in that a trader who predicts that the price of an asset will move in a particular direction can contract to buy or options it in the future at a price which if the prediction is correct will yield a profit. This contract was based on grain trading, and started a trend that saw contracts created on a number of different commodities as well as a number of futures exchanges set up in countries around the world. Inthe IMM added interest rate futures on US treasury billsand in they added stock market index futures. In this vein, the futures exchange requires both parties trading put up initial cash, or a performance bond, known as the margin. Margins, sometimes set as a percentage of the value of the futures contract, must be maintained throughout the life of the contract to guarantee the agreement, as over this time the price of the contract can vary as a function of supply and demand, causing one side of the exchange to lose money at the expense of the other. To mitigate the risk of default, the product is marked to market on a daily basis where the difference between the initial agreed-upon price and the actual daily futures price is reevaluated daily. If the margin account goes below a certain value set by the Exchange, 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. Upon marketing the strike price is often reached and creates lots of income for the "caller. Unlike use of the term margin in equities, this performance bond is not a partial payment used to purchase a security, but simply a good-faith deposit held to cover the day-to-day obligations of maintaining the position. 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 performing due diligence on their counterparty. Margin requirements are waived or reduced in some cases for hedgers who have physical ownership of the options commodity or spread traders who have offsetting contracts balancing the position. Clearing margins are distinct from customer margins that individual trading and sellers of futures and options contracts are required to deposit with brokers. Customer margin Within the futures future, financial guarantees required of both buyers and sellers of futures contracts and sellers of options contracts to ensure fulfillment of contract obligations. Futures Commission Merchants are responsible for overseeing customer margin accounts. Margins are determined on the basis of market risk and contract value. Also referred to as performance bond margin. Initial margin is the equity required to initiate a futures position. Wiki is a type of performance bond. The maximum exposure is not limited to the amount of the initial 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 wiki exchange-traded product, the amount or percentage of initial margin is set by the exchange concerned. In case of loss or if trading value of the initial margin is being eroded, the broker will make a margin trading in order to restore options amount of initial margin available. 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. A futures account is marked to market daily. If the margin drops below the margin maintenance requirement established by the exchange listing the futures, a margin call will be issued to bring future account back up to the required level. Maintenance margin A set minimum margin per outstanding futures contract that a customer must maintain in their margin account. Margin-equity ratio is a term used by speculatorsrepresenting 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 margin The 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, wiki rather it is a security deposit. ROM may be calculated realized return initial margin. Settlement is the act of consummating the contract, and can be done in one of two ways, as specified per type of futures contract: Expiry or Expiration in the U. For many equity index and Interest rate future contracts as well as for most equity optionsthis happens on the third Friday of certain trading months. For example, for most CME and CBOT contracts, at the expiration of the 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 the underlying cash 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 future 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 of those indexes to hedge against current trading 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 options half an hour. When the deliverable asset exists in plentiful supply, or may be freely created, then the price of a futures contract is determined via arbitrage arguments. This is typical for stock index futurestreasury bond futuresand futures on physical commodities when they are in supply e. However, when the deliverable commodity is not in plentiful supply or when it does not yet exist - for example on crops trading the harvest or on Eurodollar Futures or Federal funds rate futures in which the supposed underlying instrument is to be created upon the delivery date - the futures price cannot be fixed by future. In this scenario there is only one force setting the price, which is simple supply and demand for the asset in the future, as expressed by supply and demand for the futures contract. 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 underlying discounted at the wiki free rate —as 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 futures 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 futures futures price and forward price on the asset, is proportional to the covariance between the underlying asset trading and interest rates. For example, a futures on a zero coupon bond will have a futures price lower than the forward price. This is called the futures "convexity correction. 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 options, differential borrowing and lending rates, restrictions on short selling that prevent complete arbitrage. Thus, the futures price in fact varies within arbitrage boundaries around the theoretical price. When the deliverable commodity is not in plentiful supply or when it does not yet exist rational pricing cannot be applied, as the arbitrage mechanism is not applicable. In a deep and liquid market, supply and demand would be expected to balance out at a price which represents an unbiased expectation of 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 as cornering the marketthe 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. The expectation based relationship will also hold in future no-arbitrage setting when we take expectations with respect to the risk-neutral probability. In other words: a futures price is martingale with 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. The situation where the price of a commodity for future delivery is higher than the spot priceor where a far future delivery price is higher than a nearer future delivery, is known as contango. The reverse, where the price of a commodity for future delivery is lower than the spot price, or where a far future delivery price is lower than a nearer future delivery, is known as backwardation. 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 as single-stock futurescurrencies or intangibles such as interest rates and indexes. For information on futures markets in specific underlying commodity marketsfollow the links. For a list of tradable commodities futures contracts, see List of future commodities. See also the futures exchange article. Trading on commodities began 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. 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. Contracts on financial instruments were introduced in wiki s by the Chicago 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. Today, there are more than 90 futures and futures options exchanges worldwide trading to include: 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. Example: CLX14 is a Crude Oil CLNovember X contract. In other words, the investor is seeking exposure to the asset in a long futures or the opposite effect via a short futures contract. Hedgers typically include producers and consumers of a commodity or the owner of an asset or assets subject to certain influences such as an interest rate. For example, in traditional commodity marketsfarmers often sell futures 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 options can plan on a fixed cost for feed. In modern financial markets, "producers" of interest rate swaps or equity derivative products will use financial futures or equity index futures to reduce or remove the risk on the swap. 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. Speculators typically fall into three categories: position traders, day tradersand swing traders swing tradingthough many hybrid types and unique styles exist. With many investors pouring into the futures markets 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. This gains the portfolio exposure to the index which is consistent with the fund or account options objective without having to buy an appropriate proportion of each of the individual stocks just yet. When it is economically feasible an efficient amount of shares of every individual position within the fund or account can be purchasedthe 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 of riskand increased liquidity between traders with different risk and time preferencesfrom a hedger to a speculator, for example. A put is the option to sell a futures contract, and a call is the option future buy a futures contract. For both, the option strike price is the specified futures price at which the future is traded if the option is exercised. Futures are often used since they are delta one instruments. Calls and options on futures may be priced similarly to those on traded assets by using an extension of the Black-Scholes formulanamely the Black—Scholes model for futures. For options on futures, where the premium is not due until unwound, the positions are commonly referred to as a futionas they act like options, however, they settle like futures. Option sellers are generally seen as taking on more risk because they are contractually obligated to take the opposite futures position if the options buyer exercises their right to the futures position specified in the option. The price of an option is determined by supply and demand principles and consists of the option premium, or the price paid to the option seller for offering the option and taking on risk. The Commission has the right to hand out fines and other punishments for an individual or company who breaks any rules. Although by law the commission regulates all transactions, each exchange can have its own rule, and under contract can fine companies for different things or extend the fine that the CFTC hands out. The CFTC publishes weekly reports containing details of the open interest of market participants for each market-segment that has more than 20 participants. These reports are released every Friday including data from the previous Tuesday and contain data on open interest split by reportable and non-reportable open interest as well as commercial and non-commercial open interest. We describe a futures contract with delivery of item J at the time T: Wiki closely related contract is a forward contract. A future 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 the interim partial payments due to marking to market. Nor is the contract standardized, as on the exchange. Unlike an optionboth parties of a futures contract must fulfill the contract on the delivery date. Trading 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 futures position can 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. While futures and forward contracts are both contracts to deliver an asset on a future date at a prearranged price, they are different in two main respects: 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 their positions every night. Forwards are basically unregulated, while future contract are regulated at the federal government level. Futures are always traded on an exchangewhereas forwards always trade over-the-counteror can simply be wiki signed contract between two parties. Therefore: Futures are margined daily to the daily spot price of a forward with the same agreed-upon delivery price and underlying asset based on mark to market Forwards do not have a standard. They may transact only on the settlement date. More typical would be for trading parties to agree to true up, for example, every quarter. This true-ing up occurs by the "loss" party providing additional collateral; so if the buyer of the contract incurs a drop in value, the shortfall or variation margin would typically be shored up by the investor wiring or depositing additional cash in the brokerage account. In a forward though, the spread in exchange rates is not trued up regularly but, rather, it builds up as unrealized gain loss depending on which side of the trade being discussed. The result is that forwards have higher credit risk than futures, and that funding is charged differently. In wiki cases involving institutional investors, the daily variation margin settlement guidelines for futures call for actual money movement only above some insignificant amount to avoid wiring back and forth small sums of cash. Simply put, the risk of a forward contract is that the supplier will be unable to deliver the referenced asset, or that the buyer will be unable to pay for it on the delivery date or the date at which the opening party closes the contract. The margining of futures eliminates much of this credit risk by forcing the holders to update daily to the price of options equivalent forward purchased that day. In addition, the daily futures-settlement failure risk is borne by an exchange, rather than an individual party, further limiting credit risk in futures. This money goes, via margin accounts, to the holder of the other side of the future. That is, the loss party wires cash to the other party. A forward-holder, however, may pay nothing until settlement on the final day, potentially building up a large balance; this may be reflected in the mark by an allowance for credit risk. Thus, while under mark to market accounting, for both Note that, due to the path dependence of funding, a futures contract is not, strictly speaking, a European-style derivative: the total gain or loss of the trade depends not only on the value of the underlying asset at expiry, but also on the path of prices on the way. This difference is generally quite small though. With an exchange-traded future, the clearing house interposes itself on every trade. Thus there is no risk of counterparty default. The only risk is that the clearing house defaults e. By using this site, you agree to the Terms of Use and Privacy Policy.
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