Project on Futures and options

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What Does Futures Futures Mean?  Mean?

 A financial contract contract obligating obligating the buyer to to purchase an asset asset (or the seller seller to sell an asset), asset), such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical deliery of the asset, !hile others are settled in cash. "he futures mar#ets are characterized by the ability to use ery high leerage relatie to stoc# mar#ets. Futures can be used either to hedge or to speculate on the price moement of the underlying asset. For example, a producer of corn could use futures to loc# in a certain price and reduce ris# (hedge). $n the other hand, anybody could speculate on the price moement of corn by going long or short using futures.

Investopedia explains Futures

"he primary difference bet!een options and futures is that options gie the holder the right to buy or sell the underlying asset at expiration, !hile the holder of a futures contract is obligated to fulfill the terms of his%her contract. &n real life, the t he actual deliery rate of the underlying goods specified in futures contracts is ery lo!. "his is a result of the fact that the hedging or speculating speculating benefits of the contracts can be had largely !ithout actually holding the contract until expiry and deliering the good(s). For example, if you !ere long in a futures contract, you could go short in the same type of contract to offset your position. "his seres to exit your position, much li#e selling a stoc# in the equity mar#ets !ould close a trade.

Futures buy and  and sell an sell an asset at asset at a certain date at a certain price price.. For example,  An agreement agreement to buy &nestor A may ma#e a contract !ith Farmer ' in !hich A agrees to buy a certain number of bushels of 's corn at *+ per bushel. "his contract must be honored !hether the priceof priceof corn goes to * or * per bushel. Futures contracts can help reduce olatility olatility in  in certain mar#ets, mar#ets,  but they contain the ris#s inherent ris#s inherent to all speculatie inesting. "hese contracts may be sold on the  the secondary mar#et, mar#et, but the person holding the contract at its end must ta#e deliery of the underlying asset asset..

What is the difference between forward and futures contracts? Fundamentally,, for!ard and futures contracts hae the same function- both types of contracts Fundamentally allo! people to buy or sell a specific type of asset at a specific time at a gien price. contracts are  are o!eer, it is in the specific details that these contracts differ. o!eer, differ. First of all, futures contracts exchange/traded exchange /traded and, therefore, are standardized standardized contracts. For!ard contracts, contracts, on the other hand, are priate agreements bet!een t!o parties and are not as rigid in their stated terms and conditions. 'ecause for!ard contracts are priate agreements, there is al!ays a chance that a party may  may default default  on its side of the agreement. Futures contracts hae  hae  clearing houses houses   that guarantee the transactions, !hich drastically drastically lo!ers the probability probability of default to almost neer. deliery are  are quite distinct. Secondly, the specific details concerning settlement and  and  deliery For for!ard settlement of the contract occurs thechanges end of the Futures contracts arecontracts, are   mar#ed/to/mar#et  mar#ed/to/mar#et  daily, !hich means that at daily arecontract. settled day by day until the end of the contract. Furthermore Furthermore,, settlement for futures contracts can occur oer a

 

date..  range of dates. For!ard contracts, on the other hand, only possess one settlement date 0astly, because futures contracts are quite frequently employed by speculators 0astly, speculators,, !ho bet on the direction in !hich an assets price !ill moe, they are usually closed out prior to maturity and deliery usually neer happens. $n the other hand, for!ard contracts are mostly used by hedgers that !ant to eliminate the olatility  olatility of an assets price, and deliery of the asset or  cash settlement  settlement !ill usually ta#e place.

1istinction bet!een for!ards and futuresThe basic nature of a forward and future, in a strict legal sense, is the same, with the difference that futures are market-driven organised transactions. As they are exchange-traded, the counterparty in a futures transaction is the exchange. On the other hand, a forward is mostly an over-the-counter transaction and the counterparty is the contracting party. To maintain the stability of organised markets, market-based futures transactions are subject to margin reuirements, not applicable to OT! forwards. "utures market are normally marked to market on a settlement day, which could even be daily, whereas forward contracts are settled only at the end of the contract. #o the element of credit risk is far higher in case of forward contracts.

*.

Settlement ent Proced Procedures ures for the Fu Futu ture res s 2ar#et Settlem

WHY END OF DAY SETTLEMENT  ISN'T ALWAYS THE LAST TRADE #ettlement price is the price at which a contract is settled at the end of the trading day. $ith stocks this is the last trade of the day. %owever, with commodities the last trade does not have to be the settlement price. This is important because margin determinations are based on the settlement price. The exchanges have a settlement committee for each commodity which meet immediately after closing to make sure the last trade fairly represents the value for that commodity. &sually it does but if not, a new price will be established. Actively traded contracts have relatively stable pricing and the last trade normaly reflects the fair value. #ettlement price becomes more difficult for a thinly traded issue which may have last traded ' or ( hours before the close. A complicating issue which could arise might be a significant news story which came out shortly before the close of trading and which has a significant impact of the price of that particular commodity. The settlement committee will now perform an important function. They are going to try to determine

 

a price for that particular commodity which fairly represents its value in light of the news story which just broke. They may have a lot of information or very little information to make this determination. They may be able to look at the spread  between different months or this th is may be of no use to them. $hatever the ca case, se, they must determine a price which fairly represents the value of that contract)s* given the new circumstances.

Settlement - physical versus cash-settled futures #ettlement is the act of consummating the contract, and can be done in one of two ways, as specified per type of futures contract+ •



Physical delivery - the amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. hysical delivery is common with commodities and bonds. n practice, it occurs only on a minority of contracts. ost are cancelled out by purchasing a covering position - that is, buying a contract to cancel out an earlier sale )covering a short*, or selling a contract to liuidate an earlier purchase )covering a long*. The /ymex crude futures

contract uses this method of settlement upon expiration Cash settlee!t - a cash payment is made based on the underlying  reference rate,, such as a short term interest rate index such as 0uribor , or the closing rate value of a stock market index. index. The parties settle by paying1receiving the loss1gain related to the contract in cash when the contract expires. expires .234 !ash settled futures are those that, as a practical matter, could not be settled by delivery of the referenced item - ie how would one deliver an index5 A futures contract might also opt to settle against an index based on trade in a related spot market. ce 6rent futures use this method

Currency Futures What Does Currency Futures Mean? Futures Mean?

 A transferable transferable futures futures contract that specifies specifies the price at !hich a specified specified currency can can be bought or sold at a future date.

Investopedia explains Currency Futures

3urrency future contracts allo! inestors to hedge against foreign exchange ris#. Since these contracts are mar#ed/to/mar#et daily, inestors inestors can//by closing out their position//exit from their obligation to buy or sell the currency prior to the contracts deliery date.

 

How to Trade Currency Futures in India

3ontributor 'y eo! 3ontributing 4riter  Article 5ating(* 5atings)

5upee "he &ndian economy has been expanding rapidly oer the last t!enty years, and innoations in its capital mar#ets and financial instruments hae accelerated at a similar pace. 6o! independent traders, large financial institutions, trading companies, importers, exporters, and commercial hedgers hae a fully functioning system for buying and selling  &ndian 5upees all oer the !orld. 0earn the steps that can be ta#en to successfully trade currency futures in &ndia.

Step by Step Instructions •

"hings 7oull 6eed'ro#erage account



Step *



8nderstand the &ndian currency futures mar#et. "he mar#et is primarily prim arily focused on the exchange rate relationship bet!een the 8S 1ollar and &ndian 5upee. 8nli#e spot foreign exchange, in !hich one currency is bought against the sale of the other, &ndian currency futures allo! traders to bet on the anticipated direction of one currency !ithout short selling the other. &ndian currency futures are traded domestically on the 6ational Stoc# 9xchange, in 2umbai, and internationally on 1ubai :old and 3ommodities 9xchange, based in 1ubai. •

Step  $pen a bro#erage account . 7ou 7ou could either open an &ndian futures bro#erage account, !ith an outfit li#e <= 3apital Serices, or open an account !ith a 8S or&nteractie international bro#eris!ho to the &ndian mar#etplace. 'ro#ers one offers of the you fe! access 8S/based bro#ers !ith an entire diision deoted to &ndian stoc# and futures

 

trading. 5ichcomm :lobal Serices is another bro#erage that offers access to &ndian currency futures. 'e a!are that if you use an &ndian bro#er, all of your trading capital !ill probably hae to be denominated in 5upees, exposing you to exchange rate ris# if the 5upee !ere to significantly lose alue relatie to the 1ollar. •

Step > Study and follo! the fundamental factors that affect the price of the &ndian 5upee in relation to the 8S 1ollar and other international currencies. "he primary driers of price change are interest rate fluctuations, and the factors that hae the greatest impact on interest rates, such as :1? gro!th, inflation, trade tr ade balances, and international money flo!s. @eep trac# of factors that affect both the 5upee in absolute terms, as !ell as relatie to the 8S 1ollar.



Step  'ecome acquainted !ith technical analysis, and use it to decide on !hen to buy and sell &ndian currency futures. "echnical "echnical analysis is the use of price charts and indicators to better predict !hat prices !ill be doing in the future. &t can help you better determine if the 5upee is oeralued or underalued relatie to the 1ollar, and at !hat price you might consider entering a long or short position in the currency futures mar#et.



Step + &mplement a comprehensie ris# and money management plan. &ndian currency futures, li#e all futures contracts, are high ris#, high re!ard instruments, and if you trade !ithout stop losses, theres a ery good chance youll eentually get caught on the !rong side of a big moe and lose your entire account. 4hen ma#ing a trade, tr ade, al!ays #no! exactly ho! much youre !illing to lose ahead of time, as !ell as at !hat price you !ill be stopped out of the trade.

Definitions

(i) 3urrency Futures means a standardised foreign exchange deriatie contract traded on a recognized stoc# exchange to buy or sell one currency against another on a specified future date, at a price specified on the date of contract, but does not include a for!ard contract. (ii) 3urrency Futures mar#et means the mar#et in !hich currency futures are traded. Perission

(i) 3urrency futures are permitted in 8S 1ollar / &ndian 5upee or any other currency pairs, as may be approed by the 5esere 'an# from time to time.

 

(ii) $nly Bpersons resident in &ndiaC may purchase or sell currency futures to hedge an exposure to foreign exchange rate ris# or other!ise. Features of Currency Futures

Standardized currency futures shall hae the follo!ing featuresa. $nly 8S1/&65 contracts are allo!ed to be traded. b. "he contracts size of each contract shalland be 8S1 *. c. "he shall be quoted settled in &ndian 5upees. d. "he maturity of the contracts shall not exceed * months. e. "he settlement price shall be the 5esere 'an#Cs 5eference 5ate on the last trading day. Participants

(i) 6o person other than a person resident in &ndia as defined in section () of the Foreign 9xchange 2anagement Act, *DDD (Act  of *DDD) shall participate in the currency futures mar#et. (ii) 6ot!ithstanding sub/paragraph (i), no scheduled ban# or such other agency falling under the regulatory purie! of the 5esere 'an# under the 5esere 'an# of &ndia Act, *D>, the 'an#ing 5egulation Act, *DD or any other Act or instrument haing the force of  la! shall participate in the currency futures mar#et !ithout the permission from the respectie regulatory 1epartments of the 5esere 'an#. Similarly, for participation by other regulated entities, concurrence from their respectie regulators should be obtained. Mebership

i. "he membership of the currency futures mar#et of a recognised stoc# exchange shall be separate from the membership of the equity deriatie segment or the cash segment. 2embership for both trading and clearing, in the currency futures mar#et shall be subEect to the guidelines issued by the S9'&. ii. 'an#s authorized by the 5esere 'an# of &ndia under section * of the Foreign 9xchange 2anagement Act, *DDD as BA1 3ategory / & ban#C are permitted to become trading and clearing members of the currency futures mar#et of the recognized stoc# exchanges, on their o!n account and on behalf of their clients, subEect to fulfilling the follo!ing minimum prudential requirementsa) 2inimum net !orth of 5s. + crores. b) 2inimum 35A5 of * per cent. c) 6et 6?A should not exceed > per cent. d) 2ade net profit for last > years. "he A1 3ategory / & ban#s !hich fulfill the prudential requirements should lay do!n detailed guidelines !ith the approal of their 'oards for trading and clearing of currency futures contracts and management of ris#s. (iii) A1 3ategory / & ban#s !hich do not meet the aboe minimum prudential requirements and A1 3ategory / & ban#s !hich are 8rban 3o/operatie ban#s or State 3o/operatie ban#s can participate in the currency futures mar#et only as clients, subEect to approal therefor from the respectie regulatory 1epartments of the 5esere 'an#. Position !iits

 

i. "he position limits for arious classes of participants in the currency futures mar#et shall be subEect to the guidelines issued by the S9'&. ii. "he A1 3ategory / & ban#s, shall operate !ithin prudential limits, such as 6et $pen ?osition (6$?) and Aggregate :ap (A:) limits. "he exposure of the ban#s, on their o!n account, in the currency futures mar#et shall form part of their 6$? and A: limits. "is# Mana$eent Measures

"he trading of currency futures shall be subEect to maintaining initial, extreme loss and calendar spread margins and the 3learing 3orporations % 3learing ouses of the exchanges should ensure maintenance of such margins by the participants on the basis of the guidelines issued by the S9'& from time to time. %urveillance and Disclosures

"he sureillance and disclosures of transactions in the currency futures mar#et shall be carried out in accordance !ith the guidelines issued by the S9'&. &uthorisation to Currency Futures 'xchan$es ( Clearin$ Corporations

5ecognized stoc# exchanges and their respectie 3learing 3orporations % 3learing ouses shall not deal in or other!ise underta#e the business relating to currency futures unless they hold an authorization issued by the 5esere 'an# under section * (*) of the Foreign 9xchange 2anagement Act, *DDD. Powers of "eserve )an#

"he 5esere 'an# may from time to time modify the eligibility criteria for the participants, modify participant/!ise position limits, prescribe margins and % or impose specific margins for identified participants, fix or modify any other prudential limits, or ta#e such other actions as deemed necessary in public interest, in the interest of financial stability and orderly deelopment and maintenance of foreign exchange mar#et in &ndia.

Advantages of Futures Contracts  Contracts   • If price moves are favourable, the producer realizes the greatest return with this marketing alternative. No premium charge is associated with futures mar#et contracts. • Disadvantages of Future Contracts Subject to margin calls • • Unable to take advantage of favourable favourable price moves Net price is subject to Basis change •

trading volume

ide links li nks within with in definitions defi nitions

Definition !he number of shares shares,, bonds or bonds or contracts contracts traded  traded during a given  given period period,, for a  a securit" or securit" or an entire e#change. e#change. also called volume.. called  volume

 

*olue What Does Volume Volume Mean?  Mean?

"he number of shares or contracts traded in a security or an entire mar#et during a gien period of time. &t is simply the amount of shares that trade hands from sellers to buyers as a measure of actiity. &f a buyer of a stoc# purchases * shares from a seller, then the olume for that period increases by * shares based on that transaction.

Investopedia explains Volume

=olume is an important indicator in technical analysis as it is used to measure the !orth of a mar#et moe. &f the mar#ets hae made strong price moe either up or do!n the perceied strength of that moe depends on the olume for that period. "he higher the olume during that price moe the more significant the moe.

Tradin$ Tradin$+ adin$+ Futures Tradin$ Futures+ ,nline Futures Tr Trade "utures trading is a form of investment involving speculation of the price of a commodity in the future. "utures are derivatives bought or sold on a futures exchange. They are contracts to buy or sell a particular amount of a commodity at a predetermined price on a specified date in the future. Tr Tradi!" adi!" #$t$res is not for newcomers to investing, since it involves high risk. The majority of futures trading is speculative and involves cash settlements )also known as paper investing*, rather than for the actual physical delivery of the commodity. Online futures trading is not as popular as online stock trading, since the former is substantially more risky. Till the 789:s, futures trading comprised of only a handful of farm products. The  popularity of the futures f utures market subseuently subseu ently rose and in the ;7st ;7 st century it involves a huge variety of commodities, including+   metals $ like gold, silver and platinum. livestock % such as pork bellies and cattle. energ" $ like crude oil and natural gas. foodstuffs % such as coffee and orange juice. industrial products $ like lumber and cotton. currencies. indices $ such as the &ow 'ones, Nasda( and S)* +.















Trading Futures: What does it Involve?  There are two aspects that distinguish futures trading from trading in stocks or bonds.

 





- futures contract has a specified lot size. So, there could be a futures contract of  shares of IB/ or + shares of 0isco S"stems. 1ou could also opt for an inde#. 2or instance, one could opt for purchasing the 3$mini S)* + futures contract. !his gives "ou e#posure to all the stocks in this inde#. 1ou can trade with margin pa"ment. !his means that when "ou purchase a futures contract, "ou do not have to pa" the entire amount of the contract. 1ou onl" need to pa" a specified margin amount. 2or instance, "ou could purchase a futures contract for  shares of IB/ worth 45 per share at a 56 margin. !his means that instead of pa"ing 4,5 7 # 458, "ou need to pa" onl" 459 756 of 4,58. !his offers substantial leverage to the investor investor..

Benefits of Trading Futures Among the benefits of trading futures are+ •

igh leverage



igh li(uidit"



:ow brokerage fees

Dangers of Trading Futures The main risk involved in trading futures is that it is a highly speculative market.

Tradin$ adin$ futures contracts Tr "o trade futures you open an account !ith a futures bro#erage firm #no!n as a futures commission merchant (F32), !ho !ill execute and record your trades, and monitor and adise you of your   your  ar$in account obligations. 7ou may deal !ith the F32 directly or go through an introducing bro#er (&') or commodity trading adisor (3"A). As !ith stoc#s and bonds, you pay commissions and fees to trade futures. 7ou gie your bro#er an order to buy or sell a futures contract, either to open a ne! position or to offset and cancel an existing position. 7our bro#er in turn transmits the order to the appropriate  appropriate  exchan$e  electronic tradin$ syste floor or   .  7o 7ou u may also inest in futures through a commodity pool, resemblespool a mutual fund. 7our 7o urtrades inestment is pooled !ith assets from other inestors, and!hich the commodity operator (3?$) futures contracts using those funds. $r, you may !or# !ith a commodity trading adiser (3"A), to !hom you gie authority to trade in your account. 'oth 3?$s and 3"As are typically paid based on their performance. Tradin$ Tradin $ in action 

"raditionally, futures !ere traded using the open outcry auction method on exchange floors diided into "raditionally, trading pits. "oday, "oday, more and more trades are executed electronically, and trading in some commodities is entirely electronic. $n some exchanges, electronic trading systems operate alongside lie trading. $n others, open outcry occurs during the day and e/trading on those commodities ta#es place during the eening and oernight. $ther exchanges are entirely electronic, !ith no trading floor at all.

 

Mar#in$ to ar#et $er their term and een throughout a typical trading day, futures contracts change alue. At the end of each trading day, the exchanges clearin$house !ill either credit your account !ith profits or require you to add more money to bring your margin account up to the appropriate leel. "his process is called daily cash settlement, or ar#in$ to ar#et. !evera$e a$nifies 

"he ability to buy a futures contract !ith a good faith deposit or initial ar$in of * or less of the underlying commoditys alue appears to gie an inestor a lot of buying po!er. "he initial amount required to open a futures position seems relatiely small. For example, you might buy a gold contract !ith the follo!ing termsGuantity H * troy ounces 1eliery month H February ?rice in dollars per ounce H >+ 2inimum tic# H * cents per troy ounce, * per contract For only a >,+ initial margin, you !ould control a >+, inestment in a futures contract for gold. &f the price !ent up + to  per ounce, the alue of the futures contract !ould increase by +, to ,. "hat increase represents a *,+ paper gain on the initial margin of >,+. $n the other hand, if the price dropped +, the alue of the futures contract !ould drop +, to >,, and you !ould hae to add *,+ to your margin account to coer the loss in the contracts alue. &n a olatile mar#et, leeraged inesting magnifies the effect of price changes.

Tradin$ positions "here are t!o sides to eery futures contract H an inestor !ho has a lon$ position and an inestor !ith a short position. And inestors in the futures mar#et irtually al!ays ta#e both long and short positions, as they buy or sell contracts to offset existing positions. So a typical inestor !ill be a long in some contracts and a short in others. "hats not the case in the stoc# mar#et. A typical stoc# mar#et inestor ta#es a long position H buying stoc# to sell at a higher price at some future date. %ellin$ short is a higher ris# strategy that only a percentage of stoc# inestors employ, hoping to ma#e money on stoc#s that are losing alue. "o sell short, inestors borro! shares they dont o!n and sell them. "hen they !ait for the price of the stoc# to drop so they can buy the shares at the lo!er price to replace the borro!ed shares (plus interest and commission). "he longer the price ta#es to drop, the higher the interest charges o!ed to the bro#er, and the less profit possible. &n a futures contract, the short may buy an offsetting contract at any time before the expiration of the contract term. 'ecause the futures contract is a future obligation, nothing is borro!ed and interest penalties do not accrue.

Types of futures orders 4hen you place an order for a futures contract at the best price offered, the order is a ar#et order . "he price at !hich its executed may be seeral  seeral tic#s a!ay from !hat the price !as !hen you placed

 

the order. So you !ont #no! the price you paid until the order fulfillment is reported bac# to you. Contin$ent orders 

"o sole the inherent uncertainty of a mar#et order, you may also place restrictions on ho! an order is to be filled. "he most common contin$ent order  is the liit order . A limit order places a restriction on the price at !hich a contract may be bought or sold H sell orders !ill be authorized only at or aboe the liit price and and  buy orders !ill be authorized only at or belo! the limit price. 8nless other!ise indicated, a limit order is also a day order , so that if it has not been filled by the end of the trading day, it expires. :ood/til/canceled (:"3) or open orders, on the other hand, do not expire until they are filled or cancelled. "here is a range of other contingent orders possible. 2ar#et/if/touched (2&") or  stop orders trigger buying or selling if substantial mar#et olatility sends prices in a certain direction. 2ar#et/on/close (2$3) and mar#et/on/open (2$$) orders stipulate buying or selling at the mar#ets open or close.

How futures tradin$ wor#s 2ost producers and users of commodities buy and sell them in the  cash ar#et, also called the spot mar#et, because the full cash price is paid on the spot. 3ash prices are determined by supply and demand, !hich in many cases moe in predictable seasonal cycles. Fresh fruits and egetables are cheapest in the summer !hen theyre plentiful (and most flaorful). So soup, Euice, and Eam manufacturers plan their production season to ta#e adantage of the highest/quality produce at the lo!est prices. 'ut supply and demand is also affected by unpredictable eents. 1rought might !ipe out a !heat crop, causing the cash price of !heat to soar. ?olitical turmoil in the :ulf region might threaten the oil supply and cause the cash price of energy commodities to rise. "he futures mar#et is designed to help protect producers and users from Eust such price ris#s. Farmers, loggers, manufacturers, and ba#ers can buy futures contracts in the products they produce or use to smooth out the unexpected price fluctuations. %upply and deand+ plus expectations 

Futures prices tend to trac# cash prices closely, but not identically. "he difference bet!een the futures contract price and the cash price of the underlyin$ coodity is the basis. Futures prices are determined not only by supply and demand, but also by traders expectations of a host of other factors, including !eather changes, enironmental conditions, political situations, and !hat the mar#et !ill bear.

TYPES OF F%T%RES TRADIN& CONTRACTS  There are mainly two types of futures trading contracts. They are futures contracts which are traded for physical delivery, known as commodities and futures contract which are end with a cash settlement, known as financial instruments. 6oth types of futures contracts are traded electronically and directly. "utures contracts which are traded for physical delivery includes agricultural commodities like wheat, oats, sugar etc, energy products like crude oil, heating oil, natural gas etc, or animals. /ote that very commodity futures contracts actually end in delivery. Often these contracts are traded just like shares of a stock market, according to the changes in price trends. Online futures traders include both speculators and hedgers. "utures contracts which are traded for cash settlement involve treasury notes, bonds,

 

etc. These futures are also known as currency futures and are often traded just like commodity futures though electronic platforms.

Fi!a!cial #$t$res are futures contract based on financial instruments such as

Treasury bonds, currencies and !<s. These underlying assets are contracted to be  bought at a specified price on a specified date. da te. "inancial futures may also in involve volve contracts on short term interest rates )#T=*.

How are Financial Futures Traded?  "inancial futures are highly standardi>ed contracts that are traded in organi>ed futures exchanges across the world. The mode of trade is open outcry on the floor of these exchanges. 0xamples include the nternational oney arket in !hicago and ?ondon nternational "inancial "utures 0xchange )?""0* in ?ondon. The contractual agreement stipulates the terms of the agreement such as the number of units of the financial instrument, the names and details of the parties to the contract, futures and of thethe specified future delivery The transfer of profits or losses the accrues on price the basis difference between the date. settlement price and the financial futures price. "or instance, a buyer who purchases a @une '-month 0urodollar contract is committing to deposit 7 million 0urodollars in @une for ' months. Additionally, the deposit would be done at an interest rate that is agreed upon at the time of the contract. The actual procedure, however, depends on the exchange in which the trading is conducted. The movements of the price are tracked in terms of ticks,B which represent the minimal price fluctuations. The buyers or sellers of the futures contract are reuired to deposit an initial amount called the margins. This is deposited with the clearing house of the futures exchange. This is a fixed amount which is held with the futures exchange till the position is held.

Benefits of Financial Futures "inancial futures are hedging instruments that can help reali>e high profits and protect against risks. oreover, financial futures offer the following+ •

igh li(uidit".



-n opportunit" to avoid the actual transfer of financial instruments.

Risks of Financial Futures The risks associated with financial futures are+ • •

igh losses are possible if investors overtrade or trade without a plan. Insider trading can be a problem in futures trading, which can harm the profit prospects of other traders.

 

nvestors with a high risk appetite tend to like financial futures and their potential for short term profits.

Cdity #$t$res aim to transfer risks associated with the ownership of a commodity. The commodity may be anything, from wheat to a foreign currency. At

the time of the futures contract, the actual commodities do not physically change hands. The contract is legally binding for the transfer of commodities at a future date, which is specified at the time of entering into the contract. Also, at that moment itself, the price at which the delivery would take place in the future, is decided.

How are Commodit Futures Traded?  !ommodity futures trading are done in an organi>ed futures market. &nlike other investments such as stocks and bonds, trading in futures does not involve the actual  possession of the commodity. c ommodity. All an investor does is to speculate on o n the future direction of the price of that commodity. A well organi>ed and efficient commodities futures market is acknowledged as helpful forthe theoffsetting price discovery of commodities are traded in it. the #uch a market facilitates of transactions withoutthat actually impacting physical goods. $hen commodity futures contracts are traded with high leverage, they fall in the high risk area and get close to speculation. %owever, such kind of trading can also be done using low leverage to provide favorable payoffs. This techniue would place futures trading in the low risk spectrum.

Benefits of Commodit Futures •



!hrough commodit" futures trading, it is possible for investors to make huge profits with limited capital. Sometimes it happens even in a short period of time. &ue to its features, the commodit" futures market attracts hedgers since the" can minimize their risks. !he market also encourages competition among the traders who have the market information and price judgment.

Commodit Futures: Risks Involved  Often, some investors trade in commodity futures to get rich uickly. #uch investors are prone to losing money as they take big risks which might go against them. Trading in commodity futures is risky if it is treated as merely a speculative market. t is advisable for investors to exercise patience while making investing decisions.

 

What is a Currency Future? !urrency "utures are traded in the same manner as any other form of futures contract. contract. %owever, instead of dealing in a tangible product like pork bellies or wheat, the exchange rate between two given currencies serves as the commodity for the underlying contract.

There are two ways to settle a currency futures contract C you can hold it until maturity at which point you receive a cash settlement at the rate specified in the contract, or you can buy and sell currency contracts prior to maturity on an established exchange. There are several exchanges that speciali>e in currency futures including the !hicago ercantile 0xchange )!0*, 0uronext, and the Tokyo "inancial 0xchange to name a few of the larger currency futures trading centers. #ee #ettlement and <elivery of !urrency "utures !ontracts for more information how to settle a currency future contract.

History of Currency Futures !urrency futures were introduced by the !hicago ercantile 0xchange )!0* after the &nited #tates abandoned the 6retton $oods agreement in the early 78D:s. 6retton $oods was implemented after $orld $ar  and was intended to help 0uropean countries devastated by years of warfare to rebuild their economies. The central element of the 6retton $oods agreement was to tie the &.#. dollar to the value of gold and then force other currencies to maintain their rates within a narrow operating band of plus or minus one percent, in relation to the value of the &.#. dollar.

n 78D7 C in an attempt to deal with surging stagflation in the &.#. economy economy,, resident =ichard /ixon dropped the gold standard and devalued the &.#. dollar to 71'3th of an ounce of gold. This effectively ended the 6retton $oods restrictions leading ultimately to a market-based valuation for individual currencies.

nvestors soon saw an opportunity to speculate on exchange rate fluctuations, but currency trading at the time was the exclusive domain of large banks. These institutions operated in a closed, inter-bank market, forcing outsiders to pay high service fees in order to conduct currency transactions.

!0 traders C eager for a market in which they could themselves trade currencies C challenged the banks by launching the nternational onetary arket )* in <ecember of 78D7. nitially, the  trading facility offered currency futures in seven different currency pairs, but the Bs major contribution was that it created a market for !0 traders to deal in standardi>ed contracts where traders could be assured of high liuidity levels and a matching 1 clearing service to ensure that trades were promptly executed. The  continues today as a division of the !0.

 

Pricing Currency Futures Contracts !ontract prices for currency futures are determined by the interest rate for the country of origin for the currencies listed in the futures contract as well as the spot rates for each currency. 6y incorporating the spot rates in the contract price calculation, the differences is  is eliminated as the contract price ability to profit solely on arbitrage differences moves in tandem with fluctuations in the spot rate of either currency.

Nte( Arbitrage occurs when the same currency or commodity is listed on more than one exchange at the same time. f the price changes on one exchange but lags behind the other, an opportunity exists to profit on the difference between the two exchanges C this is known as arbitrage trading.

"or example, if the value of the 0uro were to rise in the spot currency market but the increase was not reflected in the futures market, an arbitrage opportunity would as Traders the futures price still be  based on the weaker 0uro varesult valuation. luation. could usewould this information to buy futures contracts that, in effect, were priced on stale data. 6y updating futures prices with changes in the spot market, the ability to exploit market arbitrage is greatly reduced.

The following formula is used to set the price for a contract for a given currency pair+

" E # )7 F =G x T* H )7 F =6 x T* $here+ • • • • •

F E the price for the currency futures contract S E the spot rate for the currency pair R) E the interest rate of the uote currency R* E the interest rate of the base currency T E the tenor or time to maturity )in days*

6ecause contract prices are determined C i.e. derived C from the underlying currencies, currency futures are considered a derivatives product. !urrency futures contracts are similar to  to forward rate agreements )"=As*  )"=As* and can also be used for hedging and speculation purposes. purposes . %owever, unlike "=As which are agreements  between two parties with terms ter ms as agreed to by both par parties, ties, currency futures have standard maturity dates and are offered in fixed amounts only.

 

MINIM%M PRICE CHAN&E rice changes in currency futures are expressed as pips or somewhat less commonly, as ticks. A pip C short for percentage in point C is the smallest unit of measure at which the currency pair trades. "or example, if the current exchange rate for A&<1&#< is uoted at :.8D3: and then moves to :.8D33, this is an increase of five  pips ):.8D33 C :.8D3:*. :.8D3 :*. n addition, note that this currency pair trades trad es in I7::,::: ratio  of 7+7::, this means that each pip is worth I7: A&< lots, so with a leverage ratio A&< for each A&< 1 &#< currency pair you hold )I7::,::: x :.:::7 E I7:.::*. Thus, a five-pip change is a I3: A&< swing in the price of one A&< 1 &#< contract.

t is important to note however, that not all currency pairs are expressed to four decimal places C some like the &#< 1 @J pair for example, list only two decimal  places while others are ar e expressed to three. #ome brokers bro kers are even offering uo uote te spreads to five decimal places )known as fractional pips or pipettes*. The important thing to remember however, is that it is the last number C whether it be two, four, or five places after the decimal C that represents a single pip for that currency pair.

MAR+ ,TO,MAR+ET PRICE FIA ark-to-market price fix fix is  is a theoretical valuation of all your open positions if they were settled at the current market prices. At the end of each dayBs trading, your account will be marked-to-market to ensure that you are still within the margin limits imposed by the exchange and your broker. #ee below for more information on margin and margin-based lending.

MAR&IN There are two types of margin you need to know about prior to trading currency futures. The first is initial margin C this is the money you deposit in your trading account to establish an account with your broker. f you incur losses and the amount in your account falls below a certain threshold amount as mandated by the exchange and your broker, you will then be reuired to deposit additional money C this threshold is known as maintenance or variation margin. f the balance in your account falls below the reuired maintenance margin levels, your broker will notify you through a margin call that you must bring your maintenance margin back to compliance levelsK failure to do so will result in your broker liuidating your holdings.

6uying on margin C or leveraged buying C allows you to submit trades for values considerably more than the amount you have available in your account. To illustrate the power of leveraged buying, consider a margin ratio of just ;:+7 coupled with a trading account containing I7:,:::. This means that you could trade amounts up to

 

I;::,::: )I7:,::: x ;:* thus enabling you to secure greater profits on even small  price movements.

Of course, this can work against you as well. f you have committed all your available cash to a trade and the value of the trade falls below your maintenance margin level, you will receive a margin call reuiring you to deposit additional margin to your account. "or example, consider the following scenario where an investor intends to buy a single &#< 1 !A< currency futures contract+

• •





&#< 1 !A< currency futures contracts are listed in I7::,::: !A< lots One contract is currently valued at I:.83:: !A< per &.#. dollar, or I83,::: &#< nitial margin reuired is 7:L - therefore, you need at least I8,3:: &#< margin available in your account )letBs assume that you have exactly this amount available in your account* aintenance margin reuired by your broker is D.3L - assuming that you have no other transactions in your account, you need to maintain at least ID,7;3 &#< in your account in either cash or marked-to-market value

6ased on this information, if the single dollar price moves up to :.833: !A< per &.#. dollar C a gain of fifty pips C the value of the single contract is now worth I3:: more than you paid. Jou can calculate this in one of two ways+

7. A single !A< pip is eual to I7: !A< per contract C therefore, 3: pips x I7: E I3::, or   ;. :.::3: )fifty pips* x I7::,::: !A< E I3:: !A<

%ow about if instead of gaining fifty pips, you lose ':: pips5 C again, we are assuming that you have only one order in your account+

7. ':: pips x I7: !A< E )I',::: !A<* C remember this is a loss. Jou can also calculate in this manner ;. :.:':: )':: pips* x I7::,::: E )I',::: !A<*

$hen your broker performs the mark-to-market evaluation and takes into account this loss, your available margin will fall from I8,3:: to IM,3:: !A<. This is obviously

 

 below the ID,7;3 &#< threshold you are reuired to mainta maintain in so this will trigger a margin call from your broker reuesting you to deposit sufficient funds to bring your account back to compliance.

SETTLEMENT AND DELI.ERY OF C%RRENCY F%T%RES CONTRACTS 6ecause currency futures are based on the exchange rate between two currencies, no  physical underlying underl ying commodity exists. $ith a wheat futures for example, the contract c ontract holder does have the option to take physical delivery of the wheat, although physical cash C  C taking this delivery is uite rare as most commodity futures are settled in cash concept one step further, currency futures are always settled in cash.

?ike most forms of futures trading, there are two types of investors C hedgers  hedgers  looking to protect a future transfer of funds, and speculators  speculators  looking to profit on fluctuations in the price of the contract.

ndividuals and firms that have either a future payment due or expect to receive a future payment, may use currency futures to look in a rate  rate if they have concerns that interest rate changes prior to the payment date could move against them. n other words, by buying currency futures contracts, hedgers want to make sure that a change in exchange rates wonBt cause them to receive less if they expect a future payment, or cause them to pay more if making a future payment. #ee %edging with !urrency "utures for "utures  for more information.

#peculators on the other hand, are not interested in holding a currency futures contract until it matures. These investors are looking to profit to profit on fluctuations fluctuation s in the contract  price and may sell and buy b uy several positions a day )so-called day traders*. tra ders*. &nlike hedgers that have a large transfer of funds due in the future, speculators, through the margin , move in and out of contract positions continuously and  buying power of margin, rarely hold any single contract for an extended period of time. =etrieved from Nhttp+11www.fxpedia.com1!urrency"utures Nhttp+11www.fxpedia.com1!urrency"uturesNN

What are the ris#s of tradin$ in Currency Futures?

"rading in 3urrency futures or forex trading comes !ith high leels of ris#. 9en a small aderse fluctuation in the exchange rate may result in loss of the entire deposit of someone trading in currency. $nly people haing an in/depth #no!ledge of the !or#ing of this mar#et or hae done a thorough home!or# about the ris#s inoled are adised to trade in this mar#et.

 

• • •

• • •

• •



0asy to own underlying commodity or stock.  /o need for holding1storing holding1sto ring the underlying commodity or euity. #tandardi>ed contracts guarantee the uality and uantity of underlying  product. =easonable market liuidity available for all major futures types. nstant execution of market orders. Availability of both standard and mini contracts helps traders to chooseK especially with modest accounts. Availability of around the clock electronic trading services. "utures trading usually includes simple and reasonably low commission fees and plans. 6y using futures contracts, traders can maximi>e profit or limit risk on trading other funds, euities or commodities

&dvanta$es and disadvanta$es To summari>e the aforementioned information, we can conclude that the following advantages and disadvantages accompany trading in futures contracts.

 dvantages •









#tandardi>ation of contractsP parameters on a developed market leads to hi"h li/$idity. The leverage effect permits achieving dis0r0rti!ately "reater "ai!s using a limited amount of invested funds and in the absence of financing costs, as opposed to classic margin trading. $ith futures contracts, it is possible to open shrt as 1ell as l!" 0siti!s in the same manner and at the same costs. f permitted by the respective exchange, there is a chice # several ethds #r clsi!" a 0siti! . <aily settlement of gains and losses provides for re"$lar reali2ati! # "ai!s, which the investors may utili>e.

!isadvantages •





The leverage effect works in both directions and, therefore, makes trading in futures contracts highly risky. <aily settlement of gains and losses provides for regular reali>ation of losses, for which reason an investor must have a sufficient reserve so that his or her  position will not be closed clos ed involuntarily. "utures contracts involve the same risks as may be potentially involved in other investment instruments, such as market and currency risks.

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