FNCE4040 Derivatives Chapter 2

Transcription

1 FNCE4040 Derivatives Chapter 2 Mechanics of Futures Markets

2 Futures Contracts Available on a wide range of assets Exchange traded Specifications need to be defined: What can be delivered, Where it can be delivered, and When it can be delivered Settled daily For each contract there may be multiple maturities, typically monthly, extending months, sometimes years into the future

3 Asset Classes Agricultural Grains (wheat, soy, ) Livestock Soft (coffee, cocoa, ) Forest Energy Crude Oil Refined products Natural Gas Electricity Metals Precious Metals Industrial Metals Financial Equity Interest Rate Foreign Exchange Real Estate Weather

4 Futures are traded in Lots Lot: smallest quantity one can trade Lot sizes were originally designed to represent roughly thousand USD at inception Therefore, each asset class has a different lot size A few examples for commodities in the next pages

5 Commodities lot sizes energy Commodity WTI Crude Oil Main Exchange NYMEX, ICE Contract Size 1000 bbl (= 42,000 gal) Brent Crude ICE 42,000 gal B Ethanol CBOT 29,000 gal Natural gas NYMEX 10,000 MMBTU NG Heating Oil 42,000 gal HO Gulf Coast Gasoline 42,000 gal LR RBOB Gasoline 42,000 gal RB Propane 42,000 gal PN Trading Symbol CL (NYMEX) WTI (ICE) AC (Open Auction) ZE (Electronic)

6 Commodities lot sizes livestock Commodity Main Exchange Contract Size Trading Symbol Lean Hogs LH Frozen Pork Bellies Live Cattle Chicago Mercantile Exchange 40,000 lb (= 20 tons) PB LC Feeder Cattle 50,000 lb (25 tons) FC

7 Commodities lot sizes metals Commodity Gold Main Exchange Contract Size Trading Symbol 100 oz GC Platinum COMEX 50 oz PL Palladium (CME) 100 oz PA Silver 5,000 oz SI Aluminum AH Copper (grd A) CA London Metal 25 Metric Tons Zinc ZS Exchange Lead (LME) PB Tin 5 Metric Tons SN Nickel 6 Metric Tons NI

8 Commodities lot sizes agri/soft Commodity Corn Main Exchange Contract Size Trading Symbol 5000 bu C/ZC (Electronic) Oats 5000 bu O/ZO (Electronic) Rough Rice 2000 cwt RR Soybeans CBOT 5000 bu S/ZS (Electronic) Soybean Meal 100 short tons SM/ZM (Electronic) Soybean Oil 60,000 lb BO/ZB (Electronic) Wheat 5000 bu W/ZW (Electronic) Cocoa 10 tons CC Coffee ICE Futures US 37,500 lb KC Cotton No.2 Sugar No.11 (formerly NYBOT) 50,000 lb 112,000 lb CT SB Frozen Conc. OJ 15,000 lbs FCOJ-A

9 Convergence of Futures to Spot Futures Price Spot Price Spot Price Futures Price Time Time (a) (b)

10 MARGIN

11 Margin A margin is cash or marketable securities deposited by an investor with his or her broker The balance in the margin account is adjusted to reflect daily settlement Margins minimize the possibility of a loss through a default on a contract

12 Margin Initial Margin The amount that must be deposited at the time the contract is entered into Daily Settlement At the end of every day the margin account is adjusted to reflect the investor s gain or loss At the end of the day if the margin account holds more than the initial margin then the investor may withdraw funds up to the initial margin level Variation Margin An amount, somewhat lower than the initial margin, that if the margin account falls below this level the investor receives a margin call and must post additional margin up to the initial margin level

13 Swiss Franc Futures Contract Feature Settlement Specs Physical Contract Size 125,000 Swiss Francs (CHF) Contract Unit USD per CHF Tick Size per CHF increments ($12.50) per contract.

14 Example of a Futures Trade On January 9 th An investor takes a short position in two March Swiss Franc futures contracts contract size is 125,000 CHF. futures price is USD/CHF maintenance margin is US$2,250/contract (US$4,500 in total) Initial margin is 110% of maintenance margin. Initial margin per contract is: $2475/contract ($4,950 in total)

15 Trading w/ Margin possible outcome Day Trade Price ($) Settle Price ($) Daily Gain ($) Cumul. Gain ($) Margin Balance ($) , ($275) ($275) $4, $50 ($225) $4, $1,575 $1,350 $6, ($275) $1,075 $6,025 Margin Call ($) ($33,775) ($32,700) ($27,750) $32,700 The next day the CME raised the maintenance margin requirement to $6,750. The initial margin is 110% of the maintenance margin.

16 CLEARING HOUSE

17 Clearing House Clearing House A clearing house acts as an intermediary in a futures contract It guarantees the performance of both parties to each transaction Responsible for keeping track of all the transactions that take place during a day Clearing House Member All trades must be channeled through a clearing house member Clearing house members must post funds

18 Margin Cash Flows When Futures Price Increases Clearing House Clearing House Member Clearing House Member Broker Broker Long Trader Short Trader

19 Margin Cash Flows When Futures Price Decreases Clearing House Clearing House Member Clearing House Member Broker Broker Long Trader Short Trader

20 Bilateral Clearing vs. Central Clearing House Reduces risk in cash management. Clearing house members manage margin on their net positions If two brokers have offsetting positions but settle through the same clearing house member then the clearing house member settles the margin call rather than the exchange.

21 TRADING FUTURES

22 Trading Futures Futures are settled daily it is equivalent to cash-settling the trade and entering a new one at the settlement price Closing out a futures position involves entering into an offsetting trade

23 Some Terminology Settlement price: the price just before the final bell each day used for the daily settlement process Open interest: the total number of contracts outstanding equal to number of long positions or number of short positions Volume of trading: the number of trades in one day

24 Questions When a new trade is completed what are the possible effects on the open interest? Can the volume of trading in a day be greater than the open interest? What is a typical trend of open interest at the end of the last trading day of a futures?

25 Trading Volume and Open Interest Assume a contract is just created. Below are the first five trades. Volume can only increase. Not true for OI. Trade # Volume traded Seller Buyer Resulting Position A B C Open Interest 1 10 A B B C C A B A A C TOTAL

26 Equity Futures Equity futures generally trade the front month only. The S&P 500 has contracts expiring in March, June, September and December. All trading is in the nearest expiry until just prior to expiry. At that point almost all contracts are rolled into the next nearest expiry.

27 Energy Futures Typically commodity futures trade many maturities at the same time The settlement price for the various maturities forms a term structure The slope can be upward (contango) or downward (backwardation) The shape of the term structure reflects supply/demand for the underlier for delivery in future months

28 Volume and OI towards expiration

29 DELIVERY

30 Delivery Most futures contracts are closed out before delivery If a futures contract is not closed out before maturity, it is either Cash settled by delivering the value embedded in the contract (this is common for financial futures); OR Physically settled by delivering the assets underlying the contract (this is common for commodity futures) Every contract has specific delivery rules.

31 Delivery Options When there are alternatives regarding delivery: When it is to be delivered What is to be delivered Where it is to be delivered How it is to be delivered The party with the short position makes these decisions.

32 Gold Futures Contract When? Delivery may take place on any business day beginning on the first business day of the delivery month or any subsequent business day of the delivery month, but not later than the last business day of the current delivery month. NOTE trading in the gold futures contract continues until the third last business day of the delivery month. One can continue to trade the futures contract during the delivery period.

33 Gold Futures Contract What? 100 troy ounces of gold with a weight tolerance of 5%. Either one (1) 100 troy ounce bar, or three (3) one (1) kilo bars. assay to a minimum of 995 fineness Each bar of Eligible gold must have the weight, fineness, bar number, and brand mark clearly incised on the bar

34 Gold Futures Contract Where?

35 Gold Futures Contract How? Gold must be delivered to a depository Directly from a producer; directly from an Assayer, provided that such gold is accompanied by an assay certificate; or directly from another Depository; provided, that such gold was placed in such other Depository satisfying the first two points.