Futures Markets

Futures Contracts

Futures contracts are forward contracts with the following differences:

  • They are exchange traded.
  • The contract is standardized (by the exchange).
  • They are settled daily.

Role of Exchanges

Exchanged are centralized locations with the following features:

  • They standardize contracts.
  • They aggregate supply and demand.
  • They determine limitations on who can trade and how.
  • They set limitations on borrowing and distribute risk by requiring transactions to be routed through clearing houses.

Contract Specifications

The futures exchange determines the following aspects of contracts:

  • Price units.
  • Price increments.
  • Size units.
  • When the contract trades.
  • When the contract is settled.
  • How the contract is settled.
  • Margin.

Example: E-mini S&P 500 Contract

The E-mini S&P 500 futures contract is a contract on the S&P 500 index.

  • Note that the S&P 500 is simply an index, not a traded asset.
  • The price of the E-mini is quoted in S&P 500 index points.
  • The actual size of the contract is 50x the index.
  • Margin for a single contract is $5060.

E-mini S&P 500 Specifications

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E-mini S&P 500 Specifications

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Futures Maturities

Note that many futures contracts with different maturities on the same underlying can exist at the same time.

  • For example, E-mini contracts expire on the third Friday of each Mar/Jun/Sep/Dec.
  • At any date, the next five contracts are available for trade.
  • The contract closest to expiry is called the front-month contract and is always the most liquid.

Delivery of Commodities

For commodities, delivery is an important part of the specification.

  • What type (grade) of the product can be delivered.
  • Range of dates for delivery.

Terminology

  • Open interest: Total number of contracts outstanding.
  • Trade volume: The number of contracts traded.
  • Settlement price: The last price before market close.

Volume vs. Open Interest

  • What is the difference between open interest and trade volume on a given day?
  • When are trade occurs, what are the possible effects on open interest?
  • Can trade volume be greater than open interest during day?

Margin

When investors borrow money from a broker to purchase an asset, they are buying on margin.

  • The initial margin is cash or marketable securities that an investor gives to a broker in order to purchase an asset.
  • The purchased securities are maintained in an account by the broker and are monitored.
    • Gains and losses on the securities are added to the value of the account.
  • The maintenance margin is a lower threshold for the value of the account.
    • When the value falls below, the investor must add cash or securities up to initial margin.
  • Margin accounts are typically settled daily.

E-mini Margin

For the E-mini:

  • Initial margin is $5225.
  • Maintenance margin is $4750.
  • The settlement price on 6 April 2016 was 2060.25, or a notional value of 50x2060.25 = $103012.5.
    • This implies a leverage ratio of \(\smash{\frac{103012.5}{5225} = 19.71}\)

Example: Gold Futures

Suppose that an investor buys two CME Group gold futures contracts (symbol GC) for $1450 (per troy ounce).

  • Initially margin is $6000 per contract.
  • Maintenance margin is $4500 per contract.
  • The contract size is 100 troy ounces, which implies a notional value of 1450*100 = $145,000.
  • The resulting leverage ratio is \(\smash{\frac{145000}{6000} = 24.17}\).

Example: Gold Futures

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