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Week 2: Mechanics of Futures Markets (Margins (Margin requirements depend…
Week 2: Mechanics of Futures Markets
Traders
Buy: has a
long futures position
Sell: has a short futures position
Closing out positions
The vast majority of futures contracts do not lead to delivery
Closing out a position means entering into the
opposite trade
to the original one (from buying => selling)
before maturity
Total gain or loss is determined by the change in the futures price between the
entering and closing date
Specifications
Assets
Commodity: grading (higher grading => more expensive)
Financial assets (stock)
Contract size
Delivery arrangement/ Delivery month
Price quotes (i.e: dollars or cents)
Price limits
Position limits: the maximum of contracts that a speculator may hold
Convergence of futures to spot price
If futures price > spot price => short (sell) a futures contract => futures price will fall as traders sell futures => arbitrage opportunity disappeared => when the delivery period is reached, the
futures price will be equal or very close to spot price
Margins
distinguish between
current futures price
(agreed price in the contract) and futures price
Definition: fund deposited by an investor with broker
Initial margin
Daily settlement
The investor can withdraw any balance in the margin account
in excess of the initial margin
Maintenance margin (below => margin call => top up)
Most brokers pay investors
interest
on the balance in the
margin account
Margin requirements depend on
type of traders
variability of the price of the underlying assets
Clearing house
acts as an
intermediary
in futures transactions
Market quotes
Settlement price: the price just before the final bell each day
Volume: number of contracts traded
Open interest: number of contracts outstanding (long or short position)
Delivery: the party with the short position chooses
Patterns of futures price
Normal markets
: futures price is an
increasing
function of the time to maturity
Inverted markets
: futures price
decreases
with the maturity of future contracts
Types of traders
Traders executing trades
Futures commission merchants (FCMs): follows the instructions of their clients and charges a commission
Locals: trading on their own account
Speculators
Day traders
Position traders
Scalpers
Arbitrageurs
Hedgers