Chapter 2

Mechanics of
Futures Markets

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Futures Contracts
A futures contract is a firm legal agreement between a
buyer (seller) and an established exchange or its
clearinghouse in which the buyer (seller) agrees to take
(make) delivery of something at a specified price at the end
of a designated period of time.

A futures contract is a forward contract that has

standardized terms, is traded on an organized exchange,
and follows a daily settlement procedure in which the losses
of one party to the contract are paid to the other party.

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Futures Contracts
Available on a wide range of assets
Exchange traded
Specifications need to be defined:
What can be delivered,
Where it can be delivered, &
When it can be delivered
Settled daily

3
Convergence of Futures to Spot

Futures
Price Spot Price

Spot Price Futures

Price

Time Time

(a) (b)

4
Organized Futures Trading
A futures exchange is a corporate entity
comprised of members.

Contract development: One of the exchange’s

important ongoing activities is identifying new
and useful futures contracts.

5
General Classes of Futures Traders
All traders on the futures exchange are either
commission brokers or locals.
Commission brokers simply execute transactions for
other people.
A commission broker can be an independent business
person who executes trades for individuals or institutions
or a representative of a major brokerage firm.
Locals are individuals in business for themselves who
trade from their own accounts.

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General Classes of Futures Traders

Classification by trading strategy:

hedger, speculators, spreaders, arbitrageurs

Classification by trading style:

scalpers, day traders, position traders

7
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

8
Margin Cash Flows
A trader has to bring the balance in the margin
account up to the initial margin when it falls below the
maintenance margin level
A member of the exchange clearing house only has
an initial margin and is required to bring the balance
in its account up to that level every day.
These daily margin cash flows are referred to as
variation margin
A member is also required to contribute to a default
fund

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Margin Cash Flows
initial margin
the minimum dollar amount that an investor must deposit per contract
as specified by the exchange.
At the end of each trading day, the exchange determines the
settlement price for the futures contract. This price is used to mark to
market the investors position.
maintenance margin
the minimum level (specified by the exchange) by which an investors
equity position may fall as a result of an unfavorable price movement
before the investor is required to deposit additional margin.
variation margin
the amount necessary to bring the equity in the account back to its
initial margin level.

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Example of a Futures Trade
An investor takes a long position in 2
December gold futures contracts on June 5
contract size is 100 oz.
futures price is US$1,450
initial margin requirement is US$6,000/contract
(US$12,000 in total)
maintenance margin is US$4,500/contract
(US$9,000 in total)

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A Possible Outcome (Table 2.1, page 52)
Day Trade Settle Daily Cumul. Margin Margin
Price ($) Price ($) Gain ($) Gain ($) Balance ($) Call ($)
1 1,450.00 12,000
1 1,441.00 −1,800 − 1,800 10,200
2 1,438.30 −540 −2,340 9,660
….. ….. ….. ….. ……
6 1,436.20 −780 −2,760 9,240
7 1,429.90 −1,260 −4,020 7,980 4,020
8 1,430.80 180 −3,840 12,180
….. ….. ….. ….. ……
16 1,426.90 780 −4,620 15,180

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Margin Cash Flows When Futures
Price Increases

13
Margin Cash Flows When Futures Price
Decreases

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Some Terminology
futures price
the price at which the parties agree to transact in the future.
settlement date
the designated date at which the parties must transact.
nearby futures contract
the contract with the nearest settlement date.
most distant futures contract
the contract furthest away in time from settlement.

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Some Terminology
In a long position
an investor takes a position in the market by buying a futures contract.
In a short position
an investor takes a position in the market by selling a futures contract.
Two choices on liquidation of the position:
Position be liquidated prior to the settlement date by taking an offsetting
position in the same contract.
Position be liquidated until the settlement date.
• Party purchasing a futures contract accepts delivery of the underlying
asset at the agree-upon price.
• Party selling a futures contract delivers the underlying asset at the
agree-upon price.

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Some Terminology
Open interest: the total number of contracts
outstanding
equal to number of long positions or number of short
positions
Settlement price: the price just before the final bell
each day
used for the daily settlement process
Volume of trading: the number of trades in one day

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Key Points About Futures

They are settled daily

Closing out a futures position involves
entering into an offsetting trade

Most contracts are closed out before maturity

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Crude Oil Trading on May 14,
2013
Open High Low Prior Last Change Volume
Settle Trade

Jun 2013 94.93 95.66 94.50 95.17 94.72 −0.45 162,901

Aug 2013 95.24 95.92 94.81 95.43 95.01 −0.42 37,830

Dec 2013 93.77 94.37 93.39 93.89 93.60 −0.29 27,179

Dec 2014 89.98 90.09 89.40 89.71 89.62 −0.09 9,606

Dec 2015 86.99 87.33 86.94 86.99 86.94 −0.05 2,181

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Development of Futures Markets
In 1848, a group of businessmen formed the Chicago Borad of
Trade (CBOT).
In 1865, the first futures contract was developed. It provided that
a farmer could agree to deliver the grain at a future date at a
price determined in advance.
For the first 120 years, futures exchanges offered trading in
contracts on commodities such as agricultural goods and metals.
In 1972, the first financial futures was developed for foreign
currency futures.

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Development of Futures Markets
In 1976, the first futures contract on a government security;
the short-term financial instrument - 90-day US Treasury bills
was developed.
In 1977, US Treasury bond futures was developed.
In 1980s, the stock index futures contract was developed.

Over the years, there has been a tremendous degree of

competition between the futures exchanges to introduce new
contracts that would generate significant trading volume.

21
Collateralization in OTC Markets

It is becoming increasingly common for transactions

to be collateralized in OTC markets
Consider transactions between companies A and B
These might be governed by an ISDA Master
agreement with a credit support annex (CSA)
The CSA might require A to post collateral with B
equal to the value to B of its outstanding transactions
with B when this value is positive.

22
Clearing Houses and OTC Markets
Traditionally most transactions have been cleared
bilaterally in OTC markets
Following the 2007-2009 crisis, the has been a
requirement for most standardized OTC derivatives
transactions between dealers to be cleared through
central counterparties (CCPs)
CCPs require initial margin, variation margin, and
default fund contributions from members similarly to
exchange clearing houses

23
Bilateral Clearing vs Central Clearing House

Bilateral Clearing Central Clearing

24
New Regulations
New regulations for trades between dealers
that are not cleared centrally require dealers
to post both initial margin and daily variation
margin
The initial margin is posted with a third party

25
Delivery
If a futures contract is not closed out before
maturity, it is usually settled by delivering the
assets underlying the contract. When there are
alternatives about what is delivered, where it is
delivered, and when it is delivered, the party
with the short position chooses.
A few contracts (for example, those on stock
indices and Eurodollars) are settled in cash

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Questions
When a new trade is completed what are
the possible effects on the open interest?
Can the volume of trading in a day be
greater than the open interest?

27
Types of Orders
Limit Discretionary
Stop-loss Time of day
Stop-limit Open
Market-if touched Fill or kill

28
Regulation of Futures
In the US, the regulation of futures
markets is primarily the responsibility of
the Commodity Futures and Trading
Commission (CFTC)
Regulators try to protect the public
interest and prevent questionable trading
practices

29
Forward Contracts vs Futures Contracts

FORWARDS FUTURES
Private contract between 2 parties Exchange traded

Non-standard contract Standard contract

Usually 1 specified delivery date Range of delivery dates

Settled at end of contract Settled daily

Delivery or final cash Contract usually closed out

settlement usually occurs prior to maturity
Some credit risk Virtually no credit risk

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Foreign Exchange Quotes
Futures exchange rates are quoted as the
number of USD per unit of the foreign currency
Forward exchange rates are quoted in the same
way as spot exchange rates. This means that
GBP, EUR, AUD, and NZD are quoted as USD
per unit of foreign currency. Other currencies
(e.g., CAD and JPY) are quoted as units of the
foreign currency per USD.

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臺灣期貨交易所
OTC Derivatives Central Clearing (2022/07/25)
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CCCP/index.html

保證金一覽表
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• 結算會員名冊
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臺指期貨契約規格

「臺灣證券交易所股價指數期貨契約」規格
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「臺灣證券交易所股價指數小型期貨契約」規
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