Lecture 3. Futures operation

Transcription

1 Lecture 3 Futures operation Agenda: 1. Futures contracts: ~ Specification ~ Convergence of futures price to spot price at maturity: 2. Margin trading: ~ Open a margin account and deposit the initial margin ~ Clearinghouse and clearing margins ~ Delivery ~ Types of traders 3.F 0 E(S T )? 4. Regulation ~ Accounting and Tax

2 1. Futures contracts ~ Futures contracts range from commodity, stocks, indices, to weather They are traded in exchanges only (CBOT, CME, LIFFE, TIFFE, SIMEX, SFE) ~ Most of the Futures contracts are closed out (squared) before the delivery period. ~ The specification of the futures contract: The asset: Commodity (very ambiguous): specify grades, quality, and substitutions if allowed. The contract size: Corn futures, Cotton futures, Lumber futures, wheat futures, rough rice futures, Frozen pork bellies futures. Financial assets (well defined): Currency futures, index futures. T-bond futures contracts traded on the CBOT If the contract size is too large: low liquidity, low participation. If the contract size is too small: high transaction costs. NASDAQ 100 ~ $100 index Mini NASDAQ 100 ~ $20 index Delivery Arrangements: ~ Who decides to deliver: seller (the party shorting the futures) ~ Where it can be delivered: Transportation costs. ~ When it can be delivered: Exchanges need to specify the delivery period during the delivery month. Usually, the delivery period is the whole delivery month. The first and last delivery dates are specified. ~ What can be delivered? Price quotes: T-bill futures (CME) T-bond futures (CBOT) 1

3 Daily price movement limits: When a futures contract is limit up or limit down, trades ceases for the day. Prevent large price movements caused by speculation. Create an artificial barrier to trading when price movements are driven by fundamentals. Position limits: Prevent speculators from exercising undue influence on the market. The maximum number of contracts that a speculator may hold. Bona fide hedgers are not subject to position limits. ~ Convergence of futures price to spot price at maturity: F T =S T If F T > S T : If F T < S T : Short futures Buy the asset Make delivery Short the asset Buy futures Receive delivery S T ( F ) F S F Time 2

4 2. Margin trading Margin system is to reduce default risk of market participants. ~ Open a margin account and deposit the initial margin: Mark to market: The margin account is adjusted daily to reflect the investor s gain or loss. The investor can withdraw the gain. The investor needs to top up the margin account if receives margin call. (In case that account balance is below maintenance margin level.) Purchase of a gold futures contract (contract size: 100 ounces) Initial margin/contract: $2,150 Maintenance margin/contract: $1,650 Date Futures price Daily gain (loss) Cumulative gain (loss) Margin account balance Maintenance margin 01/ $2,150 $1,650 01/ $1,850 01/ $2,350 01/ $1,550 MC ~ $600 01/ $1,950 01/ $2,250 01/ $2,950 Interest earnings on a margin account. Initial margin requirements: cash (100%), T-bills (90%), stocks (50%). Initial margin and maintenance margins (i.e., 75% of the initial margin) are set by the exchanges. o volatility, initial margin, maintenance margin. Speculators Day trader Spread transaction Hedgers 3

5 ~ Clearinghouse and clearing margins: Guarantee the performance of the parties to each transaction. Require members (i.e., brokerage firms) to deposit clearing margins. In determining the clearing margins, currently clearinghouses use a net basis. ~ Futures quotation: If a clearing house member has three clients: one with a long position of 100 contracts, one with a short position of 50, and another with a short position of 25, the net margining would calculate the clearing margin on the basis of 25 contracts. Settlement price: It is relevant marking to market. The average of the prices immediately before the bell Open interest: the total number of contracts outstanding. Patterns of futures prices: maturity, prices Normal market maturity, prices: Inverted market maturity, prices: mixed market ~ Delivery: 1. Seller: first notice date, last notice date, last trading date 2. Broker: issues a notice of intention to deliver 3. Clearinghouse: choose the party holding the longest positions. To avoid taking delivery, investors need to close out positions prior to the first notice date. ~ Types of traders: Commission brokers: follow clients instructions and earn commission. Locals: trade on their own account. Orders: Market orders Limit orders Stop order (stop-loss order) Stop-limit orders Market-of-touch orders Discretionary (Market-not-held) orders Good-till-canceled orders Fill-or-kill order 4

6 3. F 0 E(S T )? ~ Expected future price (market average opinion about the future price): Is futures price an unbiased predictor of the asset price at maturity? Because of the risk premium in futures markets: If hedgers tend to hold short positions and speculators hold long positions: F 0 < E(S T ) (normal backwardation) (Speculators wants to long at a lower price.) If hedgers tend to hold long positions and speculators hold short positions: F 0 > E(S T ) (Contango) (Speculators wants to short at a higher price.) 5

7 ~ Who regulates the futures markets: ~ Accounting and Tax: 4. Regulation: Commodity Futures Trading Commission (CFTC) National Futures Association (NFA) SEC The Federal Reserve Board The U.S. Treasury Department Corner the market If a contract is used for Hedging: it is logical to recognize profits (losses) at the same time as on the item being hedged Speculation: it is logical to recognize profits (losses) on a mark to market basis 09/04: Long a corn futures contract at $435 12/04: $440 02/05: Close out at $ 445 in 2004: Gain~ $440-$435 in 2005: Gain:~$445-$440 Total: $445-$435 After 2000, according to FAS 133, all derivatives are required to be included on the balance sheet at fair market value. For regular taxpayers, 60% of gains (losses) on futures contracts are treated as long-term capital gains (losses) and 40% are treated as short-term capital gains (losses). For hedgers, gains (losses) are treated as ordinary income. 6

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