Futures Markets Exchange Operations Primary Functions of Futures
- Slides: 44
Futures Markets Exchange Operations
Primary Functions of Futures Markets • 1. Manage Price Risk for Hedgers • 2. Price Discovery
Distinguishing Futures from Cash • Cash Transactions – Cash for Immediate Delivery – Cash Forward Contracts - OTC – All terms negotiated – Nothing Standardized
Distinguishing Futures from Cash • Futures Contracts – Standardized on time, quality, quantity and place, Only variable – Price – Traded on Organized Exchange
Distinguishing Futures from Cash Forward Contracts (CFC) • Key Differences – – – – Organized exchange vs. One-On-One Standardized vs. Tailored Contracts Futures more liquid Futures have strict trading rules vs. CFC regulated only by Contract Law. Futures normally offset vs. CFC normally delivered Futures involve third party vs. CFC person-toperson Futures require margin deposit as performance guarantee vs. CFC normally do not.
Futures Exchanges Common Characteristics • Futures contracts must be traded in the pits (electronic) • Are Voluntary - facilitate trading • Membership limited and hold value as an asset. • Most exchanges limit ownership of the membership to individuals.
Membership Values – CBOT $265, 000 (8/18/14); $221, 000 (8/10/16); $320, 000 (8/14/18) – CME $610, 000 (8/13/14); $395, 000 (8/15/16); $590, 000 (8/20/18) – NYMEX $250, 000 (8/4/14); $235, 000 (8/12/16); $124, 000 (8/15/18) – COMEX $117, 500 (8/21/14); $98, 000 (8/12/16); $60, 000 (8/16/18)
Objectives of Futures Markets • Provide plan for trading • Write contracts • Establish trading rules & standards of business • • • conduct Supervise and enforce rules & Standards Settle disputes & guarantee contract settlement Collect market information & disseminate to public
Characteristics of Commodities with Futures Contracts • 1948 • Today • Homogeneity – • Capable of description Fungible • Large & uncertain • Capable of description demand & supply with • Active & Large Market fluctuating prices – Uncertain prices • Centralized market • Available Market Info. • Storability • Economic need
Exchange Operations – Trading Room – pre-Globex • Room with trading pits (electronic), market • • • monitors (regulators and reporters) and phone clerks around perimeter of room to take orders. Pit – Typically polygonal with steps leading down to center. Center usually reserved for current & most active contract. Steps along each side of polygon is separate contract month. Trading hours – Limited and depend on commodity. Bell – Begins and ends trading day with warning prior to opening and closing.
CME Trading Floor Fundamentals of Futures and Options Markets, 7 th Ed, Ch 1, Copyright © John C. Hull 2010 11
Multiple Auction Procedure – pre -Globex • Open outcry and Hand signals – gives equal • access to all bids and offers. Outcry – Yell bids and offers for all to hear. – Sellers yell quantity first, then price. – Buyers yell price first, then quantity. • Hand signals – – – Palm in is buy, Palm out is sell, fingers vertical (or near face) quantity, fingers horizontal (or away from body) price.
Trade Cycle Customer Account Executive FCM Phone Clerk Time Stamp Runner Clearinghouse Time Stamp Floor Broker *Everyone who handles customer accounts must pass the “Series 3” exam administered by the National Association of Securities Dealers, register with the Commodity Futures Trading Commission (CFTC) and become members of the National Futures Association (NFA).
Traders • Brokers – Fill orders for fee – Can’t trade in front of customer (dual trading) – Must offer all trades to all traders • Speculators (Locals) – trade own accounts – Scalper – buy (sell) one tick from market. Provide liquidity. Market makers – Day traders – Take larger positions throughout day, rarely over night – Position traders – Hold positions for days or longer in anticipation of larger moves. • Hedgers – Buy or sell to manage risk of cash position
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Reading Quotations • Commodity description – commodity, exchange, volume in • • • 1 contract, how price is quoted Listed by contract month Day’s trading range – Open is first trade of day, Hi is highest price for day, Lo is lowest price of day and Settle is price at end of day. Lifetime Hi/Lo – Highest and lowest prices for contract over the life of contract. Change from previous day – today’s price less price of previous day settle. Open interest – total contracts that are open at close of day for a contract month and the total for all months. Previous day’s Volume and today’s estimated volume
Origination and Settlement of Contracts • Origination occurs when a new position is established. – Buyer is long Every trade has a long and a – Seller is short – Zero Sum Game less trading costs – Don’t need a cash position, only a promise
Origination and Settlement of Contracts • Settlement – Offsetting - Complete a transaction with exact same contract from the opposite position. • If long then sell • If short then buy – Delivery also results in settlement. • Only time title changes hands
Origination and Settlement of Contracts Trade Log 1 Long Short Contracts Open Trading Trader Traded Inter. Volume A B 1 1 1 2 3 D E C D 2 2 3 3 2 2 4 B A 1 2 1 5 C E 2 0 2 Net 0 8
Placing orders Components of an order • Name • Time limit – Time limit (e. g. , Day) vs. Open ended. • Contract – Commodity, exchange, month, year. • Type of order – Buy vs. Sell • Volume – number of contracts • Price – Specific price vs. market.
Types of Orders • Market order – Order to take position at best • • • possible price. Price Limit Order – Order to take a position in the market as soon as possible when the price is as good or better than price limit given in order. Market-if-touched – Order to fill at best price when a price has been touched. Stop Order – Usually placed to limit loss on position, or protect accrued profits. Could be Price Limit or Market-if-touched.
Types of Orders • Trailing Stop – Stop order which ratchets as • • • price moves to the benefit of a position. Placed to limit losses (lost profits) on trend reversals. Scale-in Order – Series of market-if-touched or price limit orders placed to add to profitable positions. Fill-or-Kill – Combined price limit and time limit order. Fill at X price or better in Y time or cancel. Cancel – Cancels existing order.
Spread Orders • Spread Orders – simultaneous buy and sell of different contracts – Inter-delivery – Spread on same commodity at same exchange, just different months. – Inter-market – Spread on same commodity and month, but different exchanges. – Inter-commodity – Spread on same month for different commodities, e. g. , Soybeans, Soy Oil, and Soybean Meal
Clearing Operations Responsibilities of the Clearinghouse • 1. Clear all trades • 2. Collect & Maintain Margin Monies • 3. Regulate Delivery • 4. Settle All Accounts • 5. Report Trading Data
Membership in Clearinghouse • All trades must be cleared by a Clearinghouse member • Most members are companies, but can be individuals. • Capital requirements for membership vary, but are considered rigid to maintain the integrity of the Clearinghouse
Clearing Trades • Clearinghouse is 3 rd party to all trades – Have no net positions, they take a long and short position on all trades – Guarantor on all trades. Member firms guarantee the funds of the clearinghouse. • All trades reconciled at end-of-day. – Errors reconciled with ‘Out Trades’ – All trades must be reconciled before trading resumes following day.
Clearing Operations Responsibilities of the Clearinghouse • 1. Clear all trades • 2. Collect & Maintain Margin Monies • 3. Regulate Delivery • 4. Settle All Accounts • 5. Report Trading Data
Members Margining Trades With Clearinghouse • Clearinghouse margins set by Clearinghouse • • Margin Committee and then approved by Clearinghouse Board of Directors. Margins set to guarantee the integrity of all trades. Margins for Clearinghouse Members may be satisfied with cash, interest bearing government securities, and letters of credit from a bank.
Customer margin requirements with an account executive • Initial Margin – Amount required to establish • • • a position. For most commodities, it is 5% 8% of commodity value depending on inherent price risk of the commodity. Maintenance Margin – Minimum balance required in your account to maintain a position. Generally about 75% of initial margin. Excess funds can be drawn down to the initial margin level. Broker can liquidate any position not meeting margin requirements.
Mark-To-Market • The Clearinghouse and Account Executive compute balances in margin accounts to the settlement price at the close of each trading day. – Losers are debited – Gainers are credited
Margin Calls • Call for additional funds if the margin account balance falls below the maintenance margin level. • Customer will be required to deposit funds to bring the margin account back to the initial margin level.
Distinguishing Clearinghouse Margin Accounts (FCM) from customer margin accounts • For FCM, initial margin equals maintenance • • margin. For customer, initial margin is larger than maintenance margin. FCM’s profit by posting margins only on ‘Net Positions’ of all clients. Customers hold only net positions. FCM’s profit from income earned on excess margin cash they hold on total positions over net positions.
Distinguish Futures Contract Margins from Securities Trading Margins • Ownership is transferred with securities, but not with futures contracts. • Securities margins considered down payment whereas futures contract margins considered performance guarantee. • Margins generally larger for securities.
Margining Futures Example IM=$550, MM=$450. Initial trade at $5. 02 on 5, 000 bu. Day/Closing Price Thurs/$5. 04 Fri/$$5. 00 Mon. /$4. 95 Buyer Value Change (. 02 X 5000) =$100 (. 04 X 5000) =$200 (. 05 X 5000) =$250 Margin Call =$550 -$200 =$350 Buyer Acct. Balance $550+$100 = $650 -$200 = $450 -$250 = $200+$350 = $550 Seller Acct. Balance $550 -$100 = $450+$200 = $650+$250 = $900
Clearing Operations Responsibilities of the Clearinghouse • 1. Clear all trades • 2. Collect & Maintain Margin Monies • 3. Regulate Delivery • 4. Settle All Accounts • 5. Report Trading Data
Regulating Delivery • All futures contracts are either offset or end in ‘delivery’. • Delivery option helps insure that futures contract price follows cash market price. – Why? Arbitrage • Many commodities pass delivery with a ‘cash settlement’, i. e. , close out all open positions on expiration of contract.
Clearinghouse regulates the physical delivery process. • Receives and makes payments. • Passes delivery notices. • Transfers titles • Insures commodity meets contract specifications. • Gets the commodity in the right location
Process for physical delivery • First Position Day – Clearing firm representing longs declares all open positions and reports to clearinghouse and to customers. Usually 2 days before first day allowed for delivery. • Day 1 Position Day – Clearing firm of seller notifies Clearinghouse that their customer wishes to deliver.
Process for physical delivery • First Position Day • Day 1 Position Day • Day 2 Position Day – Prior to opening on day following Day 1 Position Day, Clearinghouse matches seller with oldest reported long position and notifies both. On most exchanges, buyers can retender these notices to find another buyer.
Process for physical delivery • First Position Day • Day 1 Position Day • Day 2 Position Day • Day 3 – Delivery Day – Buyers clearing firm presents check to sellers clearing firm and title passes. Cash settlement procedures tie payments to change in contract value with no change in product or title (much like contract offset).
Clearing Operations Responsibilities of the Clearinghouse • 1. Clear all trades • 2. Collect & Maintain Margin Monies • 3. Regulate Delivery • 4. Settle All Accounts • 5. Report Trading Data
Settling Accounts • Mark-To-Market all margin accounts at the end of each trading day. • Offsetting positions of customers and settling margin accounts. • Delivery of product and settling of margin accounts.
Clearing Operations Responsibilities of the Clearinghouse • 1. Clear all trades • 2. Collect & Maintain Margin Monies • 3. Regulate Delivery • 4. Settle All Accounts • 5. Report Trading Data
Reporting Trading Data • Report settlement prices at the close of each day. • Post price limits for the next day’s trading. • Report Volume and Open Interest for the previous day’s trading.
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