CHAPTER 3:

FUTURES
CONTRACTS

1 Dr: Manara Toukabri

 US FUTURES EXCHANGES
 Chicago Mercantile Exchange (CME):
agriculture sector, metals, energy stock
indices, foreign exchange, interet rates, real
estate and weather.
 Chicago Board of trade (CBOT):
agricultural and financial contracts are traded.
 New York Mercantile Exchange (NME):
specialized in energy and metals.

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 Figure 19.4 There are Six US Futures Exchanges

New York Board of Kansas City Board of

Trade (KCBOT)
Trade (NYBOT) Minneapolis Grain
0.2%
1.99% Exchange
0.1%
New York Mercantile
Exchange
10.59%
Chicago Board of Trade
(CBOT)
36.16%

Chicago Mercantile
Exchange
50.97%

Data Source: Exchange Web Sites. 3

INTRODUCTION
 A futures contract is an obligation to buy/sell a specific
quantity of a specific commodity at a future date for a
predetermined price.
The buyer of the future (long position) is required to
purchase the commodity
The seller of the future (short position) is required to
deliver the commodity

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TYPES OF FUTURURES
Currencies Agriculture Metals & Energy Financial

British Pound Lumber Copper Treasuries

Euro Milk Gold LIBOR

Japanese Yen Cacao Silver Municipal Index

Canadian Dollar Coffee Platinum S&P 500

Mexican Peso Sugar Oil DJIA

Cotton Natural Gas Nikkei

Wheat
Cattle

Soybeans

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INTRODUCTION
 Futures markets formalize and standardize Forward
contracting.
 Byers and sellers trade in a centralized Futures
exchnage.
 The exchange standardize the types of contracts that my
be traded :it establishes contract size, the acceptable
grade of commodity, contract delivery dates.
 Although standardization eliminates much of flexibility
availbale in Forward contracting.

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 It has the offsetting advange of liquidity, because many
traders will concentrate on the same small set of contracts.
 Futures contracts also differ from Forward contracts in that
they call for a daily setting-up of any gains or losses on the
contract.
 In the case of Forward contracts, no money changes hands
until the delivery date.
 The centralized market, standardization of contracts and
depth of trading in each contract allows Futures positions to
be liquidited easily through a broker rather than personnaly
renegotiated with the other party to the contract.

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 Because the exchange guarantees the performance of
each party to the contract costly credit checks on other
traders are not necessay.
 Instead, each trader simply posts a good faith deposit
called the margin, in order to guarantee contract
performance.

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 Futures-market participants are divided into two broad
classes: hedgers and speculators.
 Hedging refers to a futures-market transaction made as a
temporary substitute for a cash-market transaction to be
made at a later date.
 Futures market speculation involves taking a short or
long futures position solely to profit from price changes.

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THE DEALERS PLACE ORDERS
Clearing
House
Long
position/short
position
Farm
er
(short
positi
on) Farmer
(Short
position)

Flour
produc
er
(Long
positio
n)

Flour
producer
(Long
position

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THE CLEARINGHOUSE
 Central to the operation of organized futures markets is the
clearinghouse or clearing corporation for the exchange.
Whenever someone enters a position in a futures contract on
the long or short side, the clearinghouse always takes the
opposite side of the contract.
 The advantages of having a central organization providing this
role are threefold.
 (1) The clearinghouse eliminates concern over the
creditworthiness of the party on the other side of the
transaction.
 (2) It frees the original trading partners from the obligation of
delivery or offset with each other.
 (3) It provides greater flexibility in opening or closing a
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position.
EXAMPLE:

 Assume the current futures price for silver for delivery

five days from today is $7.60 per ounce (in U.S dollars).
 Suppose that over the next five days the futures price
evolves as follows.
1 contract: 5,000 ounces

Day Futures Price

0 (today) $7.60
1 $7.70
2 $7.75
3 $7.68
4 $7.68
5 $7.71
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EXAMPLE:
 The spot price of silver on the delivery date is $7.71: the convergence
property implies that the price of silver in the spot market mut equal the
futures price on delivery date.
 The daily marking to market settelments for each contract held by the long
position will be as follows:

Day Profit (loss)/once *5,000onces/contrac
t=daily proceeds

1 7.70-7.60=0,10 $500
2 7.75-7.70=0.5 $250
3 7.68-7.75=-0,7 $-350
4 7.68-7.68=0 0
5 7.71-7.68=0.3 $150
total $550 13
EXAMPLE:

 The profit on day 1 is the increase in the futures price from

the previous day, or ($7.70-$7.60) per once.
 Because each silver contract on the commodity Exchange
(CMX) calls for purchase and of delivary of5,000 ounces,
the total profit per contract is 5,000 multiplied by $0.10 .
 On day 3, when the futures price falls, the long position
margin acount will be debited by $350.
 The sum of all the daily proceeds (per ounce of silver held
long) equal : Pt-F0

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 Operation of margin account
for a long position in two gold Day Trade Settelemnt Daily Cumulative Margin Margin
futures contracts. The initial price ($) price ($) gain gain account call
balance
margin is 6,000$ per ($)
1 1,250.000 12,000
contract(or 12,000 in total) 1
2
 The maintenance margin is 3
$4,500 per contract, or $9,000 4
5
in total. The contract is entered 6
7
into on Day 1 at $1,250 and 8
closed out on Day 16 at 9
10
$1,226.90. 11
12
13
14
15
16

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THE OPERATION OF MARGIN
ACCOUNTS
 If two traders get in touch with each other directly and
agree to trade an asset in the future for a certain price,
there are obvious risks.
 One of the traders may regret the deal and try to back out.
Alternatively, the trader simply may not have the financial
resources to honor the agreement.
 One of the key roles of the exchange is to organize trading
so that contract defaults are avoided.
 This is where margin accounts come in.

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THE OPERATION OF MARGIN
ACCOUNTS
 The process by which profits or losses accrue to traders is
called marking to market.
 At initial execution of trade, each trader establishes a margin
account.
 The margin is a security account consisting of cash and near
cash securities, such as Treasury bills, which ensure that the
trader is able to satisfy the the obligations of the futures
contract. Because both parties to a futures contract are
exposed to losses, both must margin.
 The initial margin usually is set between 5% and 15% of the
value of contract.
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THE OPERATION OF MARGIN
ACCOUNTS

Initial deposit=Nbre of contract*value of

contract*Max variation
 If a trader accrues sustained losses from daily
marking to market, the margin account may fall
below a critical value called the maintenance
margin or variation margin.
Once the value of the account falls below this
value, the trader receives a margin call
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EX : CASE OF LONG POSITION ON
FUTURES
 Mr « James » buy 10 futures contracts of Brent.
 Maturity: June 2019

 Quantity : 1000 barrels

 Maximal variation: 2$/Barrel/day

 Minimal variation: 0,01$/barrel.

 5 days of transaction

 F0=107.15, F1=107.35, F2= 107.60, F3=107.45,

F4=107.05, F5= 107.55
 Calculate the value of initial deposit
 Calculate the margin call

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 EX : CASE OF LONG POSITION ON
FUTURES
 Initial deposit=N*V*Max variation
Initial deposit =10*1000*2=20000

Days Margin
D C
0 107.15
1 107.35 +2000 2000
2 107.60 +2500 2500
3 107.45 -1500 (margin
call)
4 107.05 4000 4000
5 107.55 5000 5000
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COMPARISON OF FORWARD AND FUTURES
CONTRACTS.

Forward Futures

Private contract between two parties Traded on an exchange

Not standardized Standardized contract

Usually one specified delivery date Range of delivery dates

Settled at the end of contract Settleed daily

Delivery or final cash settlement Contract is usually closed out

usually takes place prior to maturity

Some credit risk Virtually no credit risk

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 SUMMARY
 A very high proportion of the futures contracts that are traded
do not lead to the delivery of the underlying asset.
 Traders usually enter into offsetting contracts to close out their
positions before the delivery period is reached.
 For each futures contract, there is a range of days during which
delivery can be made and a well-defined delivery procedure.
 The specification of contracts is an important activity for a
futures exchange. The two sides to any contract must know
what can be delivered, where delivery can take place, and
when delivery can take place.

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SUMMARY
 Margin accounts are an important aspect of futures markets.
A trader keeps a margin account with his or her broker.
 The account is adjusted daily to reflect gains or losses, and from
time to time the broker may require the account to be topped up if
adverse price movements have taken place.
 The broker either must be a clearing house member or must
maintain a margin account with a clearing house member.

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