Forward and Futures Forward Contracts A forward contract

Forward and Futures

Forward Contracts • A forward contract is an agreement to buy or sell an asset at a certain time in the future for a certain price (the delivery price) • It can be contrasted with a spot contract which is an agreement to buy or sell immediately • It is traded in the OTC market

Forward Price • The forward price for a contract is the delivery price that would be applicable to the contract if were negotiated today (i. e. , it is the delivery price that would make the contract worth exactly zero) • The forward price may be different for contracts of different maturities

Terminology • The party that has agreed to buy has what is termed a long position • The party that has agreed to sell has what is termed a short position

Profit from a Long Forward Position Profit K Price of Underlying at Maturity, ST

Profit from a Short Forward Position Profit K Price of Underlying at Maturity, ST

Futures Contracts • Agreement to buy or sell an asset for a certain price at a certain time • Similar to forward contract • Whereas a forward contract is traded OTC, a futures contract is traded on an exchange

Crude Futures at NYMEX Jan 8, 2008 • • Feb 2008 Mar 2008 April 2008 May 2008 June 2008 July 2008 Last 96. 23 95. 93 95. 50 95. 29 94. 65 94. 51

Natural Gas at NYMEX Jan 8, 2008 • • Feb 2008 Mar 2008 April 2008 May 2008 June 2008 July 2008 Last 7. 945 7. 960 7. 932 7. 976 8. 047 8. 100

Jan 8, 2008 • Gold • Silver • Copper 880. 80 15. 820 3. 2840

Dec 31, 2009 • • • Crude oil: 79. 54 Natural gas: 5. 572 Gold: 1096. 4 Silver: 16. 822 Copper: 3. 3275

The importance of commodities • With the increasing scarcity of commodities, commodity prices will be very volatile, which will create many trading opportunities. • Commodity trading desks are the fastest expanding operations in major banks • Commodity traders become the best paid in financial markets.

Margins • A margin is cash or marketable securities deposited by an investor with his or her broker • The balance in the margin account is adjusted to reflect daily settlement • Margins minimize the possibility of a loss through a default on a contract • Example of default: HKFE in October, 1987 • A history of margins in HKFE, 4, 5, 8, 10, now?

Exercise On Jan 8, 2008, the May 2008 natural gas futures traded at NYMEX was quoted at 7. 976 per (mm. Btu). On April 9, 2008, the May 2008 natural gas futures traded at NYMEX was quoted at 10. 090 per (mm. Btu). Each contract represents 10, 000 million British thermal units (mm. Btu). The initial margin is 6600 dollars per contract. Please calculate the total profit from buying one natural gas futures contract at Jan 8 and closing out at April 9. What is the rate of return on your investment, assuming the amount of investment is the initial margin required?

Commodities Futures Trading • CME group • Monopoly of commodity trading • http: //www. cmegroup. com/

Homework 1 • On September 4, 2007, the crude oil futures traded at NYMEX was quoted at 75. 07 per barrel. On December 4, 2007, the crude oil futures traded at NYMEX was quoted at 88. 31 per barrel. Each NYMEX crude oil futures contract represents 1000 barrels. The initial margin for the contract, i. e. , the amount of money required to deposit into the clearing house, is 5775 dollars. Please calculate the total profit from buying one crude oil futures contract at September 4 and closing out at December 4. What is the rate of return on your investment, assuming the amount of investment is the initial margin required?

Homework 2 • Continued from the last question. • An investor believes oil price will drop sharply and decides to short maximum number of futures contracts. He has 30, 000 dollars in a trading account. How many crude oil futures contracts he can short? Suppose he opened the positions at Sept 4, 2007 and closed the positions at Dec 4, 2007. How much money he lost in this trade?