Forward Contracts. Futures Contracts. Forward Contracts Versus Futures

Transcription

1 Forward Contracts Lecture 4: Futures and Forwards: Markets, Basic Applications, and Pricing Principles A forward contract is an agreement between two parties in which one party, the buyer (long), agrees to buy from the other party, the seller (short), something (i.e., underlying asset) at a later date (i.e., maturity date) at a price agreed upon (i.e., delivery or forward prices) today : Financial Modelling Nattawut Jenwittayaroje, PhD, CFA NIDA Business School Exclusively over-the-counter The contract is an over-the-counter (OTC) agreement between 2 companies No physical facilities for trading OTC market consisting of direct communications among major financial institutions 1 2 Futures Contracts Similar in principle to forward contracts, but a futures contract is traded on an exchange, while a forward contract is traded OTC. the contracts are standardized and specified by the exchange, making trading in a secondary market possible. Give up flexibility available in forward contacting for the sake of liquidity. Forward contracts: the terms of the contract (contract size, maturity date, and etc.) can be tailored to the needs of the traders. Virtually no credit risk Futures exchanges provide a mechanism (known as the clearinghouse) that guarantee that the contract will be honored. For forwards contracts, creditworthiness of the seller is important. Forward Contracts Versus Futures Forward contracts Trade on OTC markets Not standardized Specific delivery date Settled at end of contract Delivery or final cash settlement usually takes place Futures Traded on exchanges Standardized contract Range of delivery dates Settled daily (by daily marking to market) Usually closed out prior to maturity 3 4

2 Derivatives Markets in Thailand Thailand Futures Exchange pcl. (TFEX) SET 50 Index Futures Single Stock Futures For example, ADVANC, PTT, and PTTEP Gold Futures, Silver Futures, and Brent Crude Oil Futures USD Futures Interest Rate Futures SET 50 Index options Call options Put options Agricultural Futures Exchange of Thailand (AFET) Futures contracts on Natural Rubber Ribbed Smoked Sheets No 3 Futures contracts on White Rice 5% Both Options Futures contracts on Tapioca Chip 5 SET50 Index Futures Contract Specifications at 21 Mar 13 6 Single Stock Futures Contract Specifications at 21 Mar 13 7 The Specification of Futures Contracts Underlying asset Particularly for commodity futures, the exchange sets allowable grade of a commodity Delivery location Place and means of delivery Contract size, e.g. For a crude oil futures contract, 1,000 barrels For the Dow Jones stock index futures, $10 per index point For the SET50 index futures, Baht1,000 per index point For a Eurodollar futures contract, $1 million of a Eurodollar time deposit Quotation Specify how a price of a futures is quoted. E.g. for the CBOT s corn futures, prices are quoted in cents per bushel 8

3 The Specification of Futures Contracts TFEX s SET 50 Index Futures Delivery months (expiration months) The main delivery months for futures are March, June, September and December. Deliverable or cash settlement contracts Deliverable contract: settled by delivery of the item Cash settlement: settled by the payment of cash Daily price movement limits Prevent large price movement from speculators. Position limits The max. no. of contracts that an investor may hold. Prevent speculators from having big influence on the market 9 SET 50 index spot = Settlement price (SP): this usually is an average of the prices of the last few trades of the day. The settlement price is used to mark-to-market the position. Volume: A number of contracts traded at 13 Jan 2014 Open interest (OI): The number of futures contracts outstanding at any given in time. 10 TFEX s Gold & Single Stock Futures TFEX s USD and Brent crude Futures USD spot = Gold spot = 19,450 KTB spot = Brent spot = *33.02 = 3,525 12

4 AFET s Futures Example of Futures Listing on CBOT Gold Futures ส นค าอ างอ ง ทองค าแท งท ม ความบร ส ทธ 96.5% ขนาดของส ญญา 1 ส ญญาม ขนาดเท าก บ ทองค าน าหน ก 50 บาท เด อนท ส ญญาส นส ดอาย เด อนค (ก.พ., เม.ย., ม.ย., ส.ค., ต.ค., ธ.ค.) ใกล ท ส ด 3 ล าด บ ช วงราคาซ อขายข นต า 10 บาท ต อ 1 ส ญญา ช วงการเปล ยนแปลงของ ราคาส งส ดแต ละว น ไม เก น + 20 % ของราคาท ใช ช าระราคาในว นท าการก อนหน า เวลาซ อขาย Pre-open : 9:15-9:45 Morning : 9:45-12:30 Pre-open : 14:00-14:30 Afternoon: 14:30-16:55 ราคาท ใช ช าระในว นส ดท าย ว นท าการก อนว นท าการส ดท ายของเด อนท ส ญญาส นส ดอาย โดย ในว นน น ส ญญาท จะหมดอาย จะซ อขายได ถ งเวลา น

5 กราฟแสดงราคาทองค าspot ก บ ราคาทองค าฟ วเจอร ส ราคา Gold Spot 13 มค ราคา Gold Futures 13 มค เปร ยบเท ยบทองค า (spot) ก บ โกลด ฟ วเจอร ส (futures) GFM10 การท าก าไรในตลาดขาข น ทองค า โกลด ฟ วเจอร ส ซ อ ม ลค า 196,000 19,900 เง นลงท น ช าระเง นเต มม ลค า วางเง นค าประก นประมาณ 10% การส งมอบส นค า ส งมอบจร ง ช าระเป นเง นสด กลย ทธ การท าก าไร ท าก าไรได เฉพาะขาข น ท าก าไรได ท งขาข นและขาลง ราคาซ อขาย ประกาศโดยสมาคมผ ค าทอง เปล ยนแปลงตลอดว นตามการซ อขาย ในตลาด 19,600 ขาย ม ลค า 199,000 ระยะเวลาการลงท น ระยะกลาง-ยาว ระยะส นว นต อว น ก าไร = 199, ,000 = 3,000 เง นลงท น 15,000 ก าไรร อยละ 20% เง นประก น 19 20

6 GFM10 19,600 ขาย ม ลค า 196,000 การท าก าไรในตลาดขาลง ซ อ ม ลค า 192,500 19,250 Clearinghouse The futures exchange provides a clearing mechanism. Without a clearinghouse, traders will face a counter-party risk With clearing house, each trader only has an obligation with the clearinghouse The clearinghouse becomes The seller of the contract for the long position The buyer of the contract for the short position ก าไร = 196, ,500 = 3,500 เง นลงท น 15,000 ก าไรร อยละ 23% The clearinghouse s position nets to zero Clearinghouse Clearinghouse 23 24

7 Margin Account Since each trader has an obligation with the exchange, and futures contracts expose to risk of loss. To protect the exchange from a possible loss on a futures contract, the exchange requires each trader to deposit an initial margin. The initial margin (deposit) is usually required between 5% to 15% of the total value of the contract. For example, for SET50 index futures, the initial margin is 85,000 per contract, or about 85,000/(1,000*880) = 10.4%. During the life of a contract, the trader must maintain their account above maintenance margin level, e.g., 5% of the total value of the contract. For SET50 index futures, the maintenance margin is 60,000 per contract, or about 60,000/(1,000*880) = 6.8%. When falls below the maintenance level, they will receive a margin call and is requested to top up the margin account to the initial margin level. 25 Daily Settlements (Marking to Market) Furthermore, the profit/loss on a futures contract is settled daily. Winning party The surplus (above initial margin) from its account can be withdrawn. Otherwise, interest is paid on the funds left in this account. Losing party Additional payments if the value of the position falls below maintenance margin Marking to market can be more than one time per day (i.e., Intra-day margin call) For a forward contract, the profit/loss is realized and settled only once at the maturity. 26 Example Suppose that the SFE SPI 200 index futures contract is now traded at 3,500 index points. Its contract size is $25 per index point. The initial and maintenance margins for each contract are 10% and 5% of the value of the contract respectively. Initial margin = 10% $87,500 (3,500 $25 ) = $8,750 Maintenance margin =5% $87,500 (3,500 $25 ) = $4,375 Day Future Price Day Future Price ,500 3,600 3,700 3,650 3,500 3,600 3,700 3,650 Daily gain/loss = $2, = $2, = -$1,250 Daily gain/loss = -$2, = -$2, = $1,250 Margin account balance for LONG positions $8,750 $11,250 $13,750 $12,500 Margin account balance for SHORT positions $8,750 $6,250 $3,750 $1,250+$8,750=$10,000 Margin call Margin call - $5,

8 Closing Out Positions (Reversing Trading) A trader can close out a position at anytime before the settlement date. Closing out a long position taking an a short position on the same contract. A trader bought a June interest rate future contract at 3,200. If in April, the interest rates futures are traded at 3,300. this trader can close out the position and realise the profit by selling (shorting) the contract. Closing out a short position taking a long position on the same contract. Closing Out Positions and Open Interest The number of contracts outstanding (i.e. number of either long or short contracts outstanding) Almost all traders (i.e., about 99%), however, liquidate (i.e., closeout) their positions before the contract maturity date. Futures contracts rarely result in actual delivery of the underlying asset. The fraction of contracts that result in actual delivery is estimated to range from less than 1 to 3%, depending on the commodity and the activity in the contract Day Future Price Day Future Price ,500 3,600 3,700 3,650 3,500 3,600 3,700 3,650 3,600 Daily gain/loss = $2, = $2, = - $1,250 3,650 3, = -$1,250 Daily gain/loss = -$2, = -$2, = $1, = $1,250 Margin account balance for LONG positions $8,750 $11,250 $13,750 $12,500 - $12,500 $9,125 $7,875 Margin account balance for SHORT positions $8,750 $6,250 $3,750 $1,250+$8,750=$10,000 $11,250 Margin call The old LONG trader sells the futures contract to a new LONG trader. Margin call - $5, Forward Contracts Versus Futures Forward contracts Trade on OTC markets Not standardized Specific delivery date Settled at end of contract Delivery or final cash settlement usually takes place Futures Traded on exchanges Standardized contract Range of delivery dates Settled daily Usually closed out prior to maturity The clearinghouse and margin account show how daily settlement and closing-out positions work 32

9 Open Interest and Volume Consider the following example on how to compute open interest and volume. Time Trading Activity Open Interest Jan 1 Jan 2 Jan 3 A buys 1 futures contract and B sells 1 futures contract E buys 1 futures contract and A sells 1 futures contract B buys 1 futures contract and E sells 1 futures contract Time Trading Activity Open Interest Jan 1 Jan 2 Jan 3 A buys 1 futures contract and B sells 1 futures contract C buys 2 futures contracts and D sells 2 futures contracts B buys 1 futures contract and D Volume Who are in the market? 1 1 A(+1) : B(-1) Volume Who are in the market? 1 1 A(+1) : B(-1) Open Interest and Volume Consider the following example on how to compute open interest and volume. Time Trading Activity Open Interest sells 1 futures contract Jan 1 Jan 2 Jan 3 A buys 1 futures contract and B sells 1 futures contract C buys 10 futures contracts and D sells 5 futures contracts and E sells 5 futures contracts B buys 3 futures contracts and A sells 1 futures contract and C sells 2 futures contracts Volume Who are in the market? 1 1 A(+1) : B(-1) Speculating using Futures and Leverage A crude oil futures contract calls for delivery of 1,000 barrels of oil. The current future price for delivery in May is $67.15 per barrel. Suppose the initial margin requirement for the oil contract is 10%. Expect crude oil prices are going to increase Long oil futures Initial margin = 10% $67,150 ($ ,000 ) = $6,715 If the price of the oil futures increase by $2 ($2/$67.15 = 2.98%) create the gain to the long futures =$2 1,000 = $2,000 or 2,000/6,715 = 29.8% The 10-to-1 ratio of % change reflects the leverage inherent in the future position. Leverage: Ability to take on relatively large exposure to the market using futures and options for a relatively small initial outlay. 35 Short hedges Hedging using futures It is a hedge that involves a short position in futures contracts It is used when the hedger already own an asset and expects to sell it at some time in the future. Long hedges It is a hedge that involves a long position in futures contracts It is used when the hedger knows it will purchase a certain asset in the futures. 36

10 Example: Hedging using Futures Consider an oil distributor (i.e. hedger) plans to sell 100,000 bbls of oil in May that wishes to hedge against a possible decline in oil prices. Each oil futures contract calls for delivery of 1,000 bbls of oil. F 0 = $67.15 per barrel. Example: Hedging using Futures Hedging strategy: short 100 oil futures contracts Consider 3 possible spot prices (S T ) of oil in May. S T S T F 0 -S T - When the spot price (S T ) in May is low, the low revenue from spot contract is offset by the profit from the short futures positions - When pt is high, the high revenue is offset by the loss from the short futures. - All cases, end up 6,715,000: elimination risk: uncertain of the spot price Forwards/Futures pricing principle Should there be any relationship between spot and forward/future prices? Is forward/futures price a consensus expected spot price at maturity? 1. Gold: An Arbitrage Opportunity? Suppose that: The spot price of gold is US$900 The 1-year futures price of gold is US$960 The 1-year US$ interest rate is 5% per annum Initial Cash Flow Cash Flow at Maturity Borrow $ (1+0.05) 1 Buy gold for $ S T Short gold futures at F 0 = S T TOTAL (1+0.05) 1 = $

11 2. Gold: Another Arbitrage Opportunity? Suppose that: The spot price of gold is US$900 The 1-year futures price of gold is US$890 The 1-year US$ interest rate is 5% per annum Initial Cash Flow Cash Flow at Maturity Sell short gold for $ S T Lend $ (1+1.05) 1 Long gold futures at F 0 =890 0 S T TOTAL 0 900(1+1.05) = $55 41 The Forward/Futures Price of Gold If the spot price of gold is S and the futures price for a contract deliverable in T years is F, then F = S (1+r ) T Cost-of-carry relationship where r is the 1-year (domestic currency) risk-free interest rate. The continuous version of cost of carry model F = Se rt where r is the 1-year continuously compounded risk-free interest rate. Future price (relative cost of buying a gold with deferred delivery) = spot price (cost of buying the gold in the market) and carrying it in inventory. Cost of carrying gold = risk-free rate If this parity is violated, this can be arbitraged as previously shown. Arbitrage: strategy to exploit the mispricing that will produce ariskless profit. In our examples, S=900, T=1, and r=0.05 so that F = 900(1+0.05) 1 = 945 $900 is spot cost, and $45 is the cost-of-carry Oil: An Arbitrage Opportunity? Suppose that: - The spot price of oil is US$120 - The quoted 1-year futures price of oil is US$135 - The 1-year US$ interest rate is 5% per annum - The storage cost of oil is $2 per barrel Initial Cash Flow Cash Flow at Maturity Borrow $ (1+0.05) 1 Buy oil for $ S T Cost of storing oil 0-2 Short oil futures at F 0 = S T TOTAL (1+0.05) 1-2 = $ Oil: Another Arbitrage Opportunity? Suppose that: - The spot price of oil is US$120 - The quoted 1-year futures price of oil is US$119 - The 1-year US$ interest rate is 5% per annum - The storage cost of oil is $2 per barrel Initial Cash Flow Cash Flow at Maturity Sell short oil for $ S T Lend $ (1+0.05) 1 Save cost of storing oil 0 +2 Buy oil futures at F 0 =119 0 S T TOTAL 0 120(1+0.05) = $9 44

12 The Forward/Futures Price of Asset with Storage Cost If the spot price of asset is S and the futures price for a contract deliverable in T years is F, then F = S (1+r) T + s Cost-of-carry relationship where r is the 1-year (domestic currency) risk-free rate of interest, and s is the dollar storage cost The continuous version of cost of carry model F = Se (r+s)t where r and s is the 1-year continuously compounded risk-free interest rate and storage cost rate. Cost of carrying asset = risk-free rate and storage cost If this parity is violated, this can be arbitraged as previously shown. In our examples, S=120, T=1, r=0.05, and s=$2 so that F = 120(1+0.05) 1 +2 = 128 $120 is spot cost, and $8 is the cost-of-carry Stock Index: An Arbitrage Opportunity? Suppose that: - The spot price of SET50 index is The quoted 6-month futures price of SET50 is The 1-year Thai Baht interest rate is 5% per annum - The dividends paid from constituent stocks in the SET50 are Baht 5 in the next 6 months Initial Cash Flow Cash Flow at Maturity Borrow $ (1+0.05) 1/2 Buy SET50 for $ S T Receive dividends 0 +5 Short SET50 futures at F 0 = S T TOTAL (1+0.05) 1/2 + 5 = $ Stock Index: An Arbitrage Opportunity? Suppose that: - The spot price of SET50 index is The quoted 6-month futures price of SET50 is The 1-year Thai Baht interest rate is 5% per annum - The dividends paid from constituent stocks in the SET50 are Baht 5 per annum Initial Cash Flow Cash Flow at Maturity Sell SET50 for $ S T Lend $ (1+0.05) 1/2 Pay dividends 0-5 Buy SET50 futures at F 0 =452 0 S T 452 TOTAL 0 450(1+0.05) 1/ = $ The Forward/Futures Price of Asset with Dividend If the spot price of asset is S and the futures price for a contract deliverable in T years is F, then F = S (1+r) T -D Cost-of-carry relationship where r is the 1-year (domestic currency) risk-free rate of interest, and D is the dollar amount of dividend paid The continuous version of cost of carry model F = Se (r-d)t where r and d is the 1-year continuously compounded risk-free interest rate and dividend yield. NetCostofcarryingasset = risk-free rate minus dividend paid If this parity is violated, this can be arbitraged as previously shown. In our examples, S=450, T=0.5, r=0.05, and D=$5 so that F = 450(1+0.05) 1/2-5 = $450 is spot cost, and $6.1 is the net cost-of-carry 48

13 7. Currency: An Arbitrage Opportunity? Suppose that: - The spot price of USD is 33 baht - The quoted 1-month futures price of USD is 33.8 baht - The 1-year Thai Baht interest rate is 5% per annum, and the 1-year US$ interest rate is 4% per annum US risk-free rate of 4% Initial Cash Flow Cash Flow at Maturity 8. Currency: An Arbitrage Opportunity? Suppose that: - The spot price of USD is 33 baht - The quoted 1-month futures price of USD is 32.8 baht - The 1-year Thai Baht interest rate is 5% per annum, and the 1-year US$ interest rate is 4% per annum US risk-free rate of 4% Initial Cash Flow Cash Flow at Maturity Borrow 33 baht (1+0.05) 1/12 Buy USD for 33 baht -33 S T Receive dividends 0 +33(1+0.04) 1/12-33 Short USD futures at F 0 = S T TOTAL [33(1+0.05) 1/12-33(1+0.04) 1/ ] =.77 Sell USD for 33 baht +33 -S T Lend 33 baht (1+0.05) 1/12 Pay dividends 0 - [33(1+0.04) 1/12 33] Long USD futures at F 0 = S T TOTAL 0 [33(1+0.05) 1/12-33(1+0.04) 1/ ] 32.8 =.23 Terms in the bracket can be Terms in the bracket can be approximated by 33( ) 1/12 49 approximated by 33( ) 1/12 50 The Forward/Futures Price of Foreign Currency Assets If the spot price of asset is S and the futures price for a contract deliverable in T years is F, then Cost-of-carry relationship F = S (1 + r - ρ ) T The continuous version of cost of carry model F = Se (r-ρ)t where r is the 1-year domestic currency risk-free interest rate, and ρ is the foreign currency risk-free interest rate NetCostofCarryingasset = domestic risk-free rate minus foreign risk-free rate If this parity is violated, this can be arbitraged as previously shown. In our examples, S=33, T=1/12, r=0.05, and d=0.04 so that F = 33( ) 1/12 = Futures Markets: Contango vs Backwardation In a Contango market, the futures price exceeds the spot price, that is, f 0 (T) > S 0. See Table 9.2. When f 0 (T) < S 0, convenience yield is c, an additional return from holding asset when in short supply/high demand or a non-pecuniary return (e.g., the utility from living in the house owned). When the commodity has a convenience yield, the futures price may be less than the spot price plus the cost of carry. In that case, the market is said to be at less than full carry and in Backwardation or inverted (See Table 9.3). Market can be both backwardation and contango --> Table 9.4. The inability to sell short the asset and the reluctance on the part of holders of the commodity to sell it when its price is higher than it should be can also produce backwardation in commodity markets. 33 is spot cost, and.03 is the net cost-of-carry 51 52

14 as of 22 March as of 29 March