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Chapter 3 Principles of Futures - Coggle Diagram
Chapter 3
Principles of Futures
Basic Requirements
deep market
every futures market must have sufficient number of buyers & sellers
easy grading
commodity selected for trading must be easily traded as its focus is an agricultural products
free fluctuation
prices must be free from fluctuation without any government control/monopoly power
active participation
participations must be active & regular to provide sufficient liquidity
Contract Specifications
underlying instrument
every futures contract has its underlying physical instrument which traded in cash market
the price of the contract is based on the actual price of the instrument
grade/quality
physical commodity: the grade is specified to ensure participants trade the same type & quality of underlying instrument
commodity futures: graded based on technical requirements of physical commodity of underlying instrument
financial futures: graded on the quality of the financial requirements
price quotations
quoted in the same basic unit as its underlying instrument
contract size
number of units/amount represented by each futures contract
contract month
traded on the basis of specified contract month
expiry date
the last day of trading in a particular contract month
Offsetting VS Settlement
offsetting
any opened contract can be closed-out before maturity by taking an offset position
settlement
any outstanding contract which has not been closed-out must be settled at maturity
physical settlement
delivering the physical underlying instrument
cash settlement
paying the amount of cash equal to the exercise price of the futures
Commodity VS Financial
financial futures
contracts which the underlying assets are the financial products
trading is based in intangible financial instrument
both parties are required to settle the cash price differential
commodity futures
commodity which the underlying assets are the commodity products
require the buyer & seller fulfill their obligation/close their contract (offsetting/settlement)
Market Participants
hedger
actual owners of physical commodity/financial instrument
spreader
speculator with dual positions at one time
inter-market
simultaneous buying & selling similar underlying instrument & contract month futures at different markets
inter-month
simultaneous trading of the same commodity & market but at different contract months
inter-commodity
trades futures of different but economically related commodities at the same market & contract month
speculator
non-owners of the instrument that are motivated by profits based on the price movements
arbitrageur
investors with dual positions at one time
attempts to take advantage of the temporary mispricing of 2 related instruments with little risk
Trading Practicalities
open VS close out position
open position
when the trader hold the futures until the maturity date
the holder need to make delivery of the assets/cash settlement
close position
entering into the opposite position from the original one
long VS short position
long position
agrees to buy the assets when the contract expires
short position
agrees to sell the assets when the contract expires
margin requirement
a legal requirement for every participants to ensure traders have sufficient funds to cover their position in the market
initial margin
amount deposited when the contract is originally purchased/sold
represents "faith money" in the form of fulfillment of the obligation of a seller/buyer
maintenance margin
the minimum amount to be maintained by investor through out the contract life
variable margin
the amount in the margin account that will vary according to the closing prices
margin call
exercised by the broker to call investor to top up the shortage of the account until it is equal to the initial margin
basis
the difference between the spot price of the underlying instrument & the futures price
convergence
cash & future prices will converge at one price at maturity
the convergence is ensured by the actions of arbitrageurs
volume & open interest
volume
the number of contracts traded
open interest
the number of outstanding contracts for a given contract month