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finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the left corn ...

finance
, a futures contract (sometimes called futures) is a standardized legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other. The
asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such a ...
transacted is usually a
commodity In economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of plan ...
or
financial instrument Financial instruments are monetary contracts A contract is a legally binding document between at least two parties that defines and governs the rights and duties of the parties to an agreement. A contract is legally enforceable because it me ...
. The predetermined price the parties agree to buy and sell the
asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such a ...
for is known as the ''forward price''. The specified time in the future—which is when delivery and payment occur—is known as the ''delivery date''. Because it is a function of an underlying asset, a futures contract is a
derivative In mathematics Mathematics (from Greek: ) includes the study of such topics as numbers (arithmetic and number theory), formulas and related structures (algebra), shapes and spaces in which they are contained (geometry), and quantities ...
product. Contracts are negotiated at
futures exchange A futures exchange or futures market is a central financial exchange An exchange, bourse (), trading exchange or trading venue is an organized market where (especially) tradable securities A security is a tradable financial asset. The term ...
s, which act as a marketplace between buyers and sellers. The buyer of a contract is said to be the
long Long may refer to: Measurement * Long, characteristic of something of great duration Duration may refer to: * The amount of Time#Terminology, time elapsed between two events * Duration (music) – an amount of time or a particular time interval, ...
position holder and the selling party is said to be the
short
short
position holder. As both parties risk their counter-party walking away if the price goes against them, the contract may involve both parties lodging a margin of the value of the contract with a mutually trusted third party. For example, in gold futures trading, the margin varies between 2% and 20% depending on the volatility of the
spot market The spot market or cash market is a public In public relations Public relations (PR) is the practice of managing and disseminating information from an individual or an organization An organization, or organisation (English in ...
. A stock future is a cash-settled futures contract on the value of a particular
stock market index In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availa ...
. Stock futures are one of the high risk trading instruments in the market. Stock market index futures are also used as indicators to determine market sentiment. The first futures contracts were negotiated for agricultural commodities, and later futures contracts were negotiated for natural resources such as oil. Financial futures were introduced in 1972, and in recent decades,
currency future A currency future, also known as an FX future or a foreign exchange future, is a futures contract In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned ...
s,
interest rate future An interest rate future is a financial derivative In finance, a derivative is a contract that ''derives'' its value from the performance of an underlying entity. This underlying entity can be an asset In financial accountancy, financial accoun ...
s,
stock market index future In finance, a stock market index future is a cash-settled futures contract on the value of a particular stock market index. The turnover for the global market in exchange-traded equity index futures is notionally valued, for 2008, by the Bank for ...
s, and cryptocurrency
perpetual futures In finance, a perpetual futures contract, also known as a perpetual swap, is an agreement to non-optionally buy or sell an asset at an unspecified point in the future. Perpetual futures are cash-settled, and differ from regular Futures contract, fut ...
have played an increasingly large role in the overall futures markets. Even organ futures have been proposed to increase the supply of transplant organs. The original use of futures contracts was to mitigate the risk of price or exchange rate movements by allowing parties to fix prices or rates in advance for future transactions. This could be advantageous when (for example) a party expects to receive payment in foreign currency in the future and wishes to guard against an unfavorable movement of the currency in the interval before payment is received. However, futures contracts also offer opportunities for
speculation Speculation is the purchase of an asset (a commodity In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), dist ...
in that a trader who predicts that the price of an asset will move in a particular direction can contract to buy or sell it in the future at a price which (if the prediction is correct) will yield a profit. In particular, if the speculator is able to profit, then the underlying commodity that the speculator traded would have been saved during a time of surplus and sold during a time of need, offering the consumers of the commodity a more favorable distribution of commodity over time.


Origin

The Dutch pioneered several financial instruments and helped lay the foundations of the modern financial system. In Europe, formal
futures market A futures exchange or futures market is a central financial exchange An exchange, bourse (), trading exchange or trading venue is an organized market where (especially) tradable securities A security is a tradable financial asset. The term ...
s appeared in the
Dutch Republic The United Provinces of the Netherlands, or United Provinces (officially the Republic of the Seven United Netherlands), commonly referred to in historiography Historiography is the study of the methods of historian ( 484– 425 BC) was ...
during the 17th century. Among the most notable of these early futures contracts were the
tulip Tulips (''Tulipa'') are a genus Genus /ˈdʒiː.nəs/ (plural genera /ˈdʒen.ər.ə/) is a taxonomic rank In biological classification In biology Biology is the natural science that studies life and living organisms, inclu ...

tulip
futures that developed during the height of the Dutch
Tulipmania Tulip mania ( nl, tulpenmanie) was a period during the Dutch Golden Age The Dutch Golden Age ( nl, Gouden Eeuw ) was a period in the history of the Netherlands, roughly spanning the era from 1588 (the birth of the Dutch Republic) to 1672 ...
in 1636. The
Dōjima Rice Exchange 250px, The Dōjima Rice Exchange Monument The Dōjima Rice Exchange (堂島米市場, ''Dōjima kome ichiba'', 堂島米会所, ''Dōjima kome kaisho''), located in Osaka, was the center of Japan's system of rice brokers, which developed independ ...
, first established in 1697 in
Osaka is a designated city in the Kansai region The or the , lies in the southern-central region of Japan , image_flag = Flag of Japan.svg , alt_flag = Centered deep red circle on a white rectangle , ...

Osaka
, is considered by some to be the first
futures exchange A futures exchange or futures market is a central financial exchange An exchange, bourse (), trading exchange or trading venue is an organized market where (especially) tradable securities A security is a tradable financial asset. The term ...
market, to meet the needs of
samurai were the hereditary military nobility and officer caste of History of Japan#Medieval Japan (1185–1573/1600), medieval and Edo period, early-modern Japan from the late 12th century to their abolition in 1876. They were the well-paid retainer ...

samurai
who—being paid in rice—needed a stable conversion to coin after a series of bad harvests. The
Chicago Board of Trade The Chicago Board of Trade (CBOT), established on April 3, 1848, is one of the world's oldest futures and options exchanges. On July 12, 2007, the CBOT merged with the Chicago Mercantile Exchange The Chicago Mercantile Exchange (CME) (often ca ...

Chicago Board of Trade
(CBOT) listed the first-ever standardized 'exchange traded' forward contracts in 1864, which were called futures contracts. This contract was based on
grain A grain is a small, hard, dry seed A seed is an embryonic ''Embryonic'' is the twelfth studio album by experimental rock band the Flaming Lips released on October 13, 2009, on Warner Bros. Records, Warner Bros. The band's first double albu ...

grain
trading, and started a trend that saw contracts created on a number of different
commodities In economics, a commodity is an economic goods, good, usually a resource, that has full or substantial fungibility: that is, the Market (economics), market treats instances of the good as equivalent or nearly so with no regard to who Production ...
as well as a number of futures exchanges set up in countries around the world. By 1875 cotton futures were being traded in
Bombay Mumbai (, ; also known as Bombay — the official name until 1995) is the capital city A capital or capital city is the municipality holding primary status in a Department (country subdivision), department, country, Constituent state, ...

Bombay
in India and within a few years this had expanded to futures on edible oilseeds complex, raw
jute Jute is a long, soft, shiny bast fiber epidermis The epidermis is the outermost of the three layers that make up the skin, the inner layers being the dermis and Subcutaneous tissue, hypodermis. The epidermis layer provides a barrier to inf ...

jute
and jute goods and
bullion Bullion is non-ferrous metal In metallurgy Metallurgy is a domain of Materials science, materials science and engineering that studies the physical and chemical behavior of metallic Chemical element, elements, their Inter-metallic alloy, in ...
. In the 1930s two thirds of all futures was in wheat. The 1972 creation of the
International Monetary MarketThe International Monetary Market (IMM), a related exchange created within the old Chicago Mercantile Exchange The Chicago Mercantile Exchange (CME) (often called "the Chicago Merc", or "the Merc") is a global derivatives marketplace based in Chi ...
(IMM) by the
Chicago Mercantile Exchange The Chicago Mercantile Exchange (CME) (often called "the Chicago Merc", or "the Merc") is a global derivatives market The derivatives market is the financial market A financial market is a market Market may refer to: *Market (economics) ...

Chicago Mercantile Exchange
was the world's first financial futures exchange, and launched
currency future A currency future, also known as an FX future or a foreign exchange future, is a futures contract In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned ...
s. In 1976, the IMM added
interest rate future An interest rate future is a financial derivative In finance, a derivative is a contract that ''derives'' its value from the performance of an underlying entity. This underlying entity can be an asset In financial accountancy, financial accoun ...
s on US treasury bills, and in 1982 they added
stock market index future In finance, a stock market index future is a cash-settled futures contract on the value of a particular stock market index. The turnover for the global market in exchange-traded equity index futures is notionally valued, for 2008, by the Bank for ...
s.


Risk mitigation

Although futures contracts are oriented towards a future time point, their main purpose is to mitigate the risk of default by either party in the intervening period. In this vein, the futures exchange requires both parties to put up initial cash, or a performance bond, known as the #Margin, margin. Margins, sometimes set as a percentage of the value of the futures contract, must be maintained throughout the life of the contract to guarantee the agreement, as over this time the price of the contract can vary as a function of supply and demand, causing one side of the exchange to lose money at the expense of the other. To mitigate the risk of default, the product is marked to market on a daily basis where the difference between the initial agreed-upon price and the actual daily futures price is re-evaluated daily. This is sometimes known as the variation margin, where the futures exchange will draw money out of the losing party's margin account and put it into that of the other party, ensuring the correct loss or profit is reflected daily. If the margin account goes below a certain value set by the exchange, then a margin call is made and the account owner must replenish the margin account. On the delivery date, the amount exchanged is not the specified price on the contract but the spot price, spot value, since any gain or loss has already been previously settled by marking to market.


Margin

To minimize counterparty risk to traders, trades executed on regulated
futures exchange A futures exchange or futures market is a central financial exchange An exchange, bourse (), trading exchange or trading venue is an organized market where (especially) tradable securities A security is a tradable financial asset. The term ...
s are guaranteed by a Clearing house (finance), clearing house. The clearing house becomes the buyer to each seller, and the seller to each buyer, so that in the event of a counterparty default the clearer assumes the risk of loss. This enables traders to transact without performing due diligence on their counterparty. Margin requirements are waived or reduced in some cases for Hedge (finance), hedgers who have physical ownership of the covered
commodity In economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of plan ...
or spread traders who have offsetting contracts balancing the position. Clearing margin are financial safeguards to ensure that companies or corporations perform on their customers' open futures and options contracts. Clearing margins are distinct from customer margins that individual buyers and sellers of futures and options contracts are required to deposit with brokers. Customer margin Within the futures industry, financial guarantees required of both buyers and sellers of futures contracts and sellers of options contracts to ensure fulfillment of contract obligations. Futures Commission Merchants are responsible for overseeing customer margin accounts. Margins are determined on the basis of market risk and contract value. Also referred to as performance bond margin. Initial margin is the equity required to initiate a futures position. This is a type of performance bond. The maximum exposure is not limited to the amount of the initial margin, however, the initial margin requirement is calculated based on the maximum estimated change in contract value within a trading day. The initial margin is set by the exchange. If a position involves an exchange-traded product, the amount or percentage of the initial margin is set by the exchange concerned. In case of loss or if the value of the initial margin is being eroded, the broker will make a margin call in order to restore the amount of initial margin available. Often referred to as “variation margin”, margin called, for this reason, is usually done on a daily basis, however, in times of high volatility, a broker can make a margin call intra-day. Margin calls are usually expected to be paid and received on the same day. If not, the broker has the right to close sufficient positions to meet the amount called by way of margin. After the position is closed out the client is liable for any resulting deficit in the client's account. Some U.S. exchanges also use the term “maintenance margin”, which in effect defines how much the value of the initial margin can reduce before a margin call is made. However, most non-US brokers only use the term “initial margin” and “variation margin”. The Initial Margin requirement is established by the Futures exchange, in contrast to other securities' Initial Margin (which is set by the Federal Reserve in the U.S. Markets). A futures account is marked to market daily. If the margin drops below the margin maintenance requirement established by the exchange listing the futures, a margin call will be issued to bring the account back up to the required level. Maintenance margin A set minimum margin per outstanding futures contract that a customer must maintain in their margin account. Margin-equity ratio is a term used by speculators, representing the amount of their trading capital that is being held as margin at any particular time. The low margin requirements of futures results in substantial leverage of the investment. However, the exchanges require a minimum amount that varies depending on the contract and the trader. The broker may set the requirement higher, but may not set it lower. A trader, of course, can set it above that, if he does not want to be subject to margin calls. Performance bond margin The amount of money deposited by both a buyer and seller of a futures contract or an options seller to ensure the performance of the term of the contract. Margin in commodities is not a payment of equity or down payment on the commodity itself, but rather it is a security deposit. Return on margin (ROM) is often used to judge performance because it represents the gain or loss compared to the exchange's perceived risk as reflected in the required margin. ROM may be calculated (realized return) / (initial margin). The Annualized ROM is equal to (ROM+1)(year/trade_duration)-1. For example, if a trader earns 10% on margin in two months, that would be about 77% annualized.


Settlement − physical versus cash-settled futures

Settlement is the act of wikt: consummating, 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. Physical delivery is common with commodities and bonds. In practice, it occurs only on a minority of contracts. Most are canceled 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 liquidate an earlier purchase (covering a long). The Nymex crude futures contract uses this method of settlement upon expiration * Cash settlement − a cash payment is made based on the underlying reference rate, such as a short-term interest rate index such as 90 Day T-Bills, or the closing value of a
stock market index In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availa ...
. The parties settle by paying/receiving the loss/gain related to the contract in cash when the contract expires. Cash settled futures are those that, as a practical matter, could not be settled by delivery of the referenced item—for example, it would be impossible to deliver an index. A futures contract might also opt to settle against an index based on trade in a related spot market. Intercontinental Exchange, ICE Brent Crude, Brent futures use this method. Expiry (or Expiration in the U.S.) is the time and the day that a particular delivery month of a futures contract stops trading, as well as the final settlement price for that contract. For many equity index futures and interest rate futures as well as for most equity (index) options, this happens on the third Friday of certain trading months. On this day the ''back month'' futures contract becomes the ''front-month'' futures contract. For example, for most Chicago Mercantile Exchange, CME and Chicago Board of Trade, CBOT contracts, at the expiration of the December contract, the March futures become the nearest contract. During a short period (perhaps 30 minutes) the underlying cash price and the futures prices sometimes struggle to converge. At this moment the futures and the underlying assets are extremely liquid and any disparity between an index and an underlying asset is quickly traded by arbitrageurs. At this moment also, the increase in volume is caused by traders rolling over positions to the next contract or, in the case of equity index futures, purchasing underlying components of those indexes to hedge against current index positions. On the expiry date, a European equity arbitrage trading desk in London or Frankfurt will see positions expire in as many as eight major markets almost every half an hour.


Pricing

When the deliverable asset exists in plentiful supply or may be freely created, then the price of a futures contract is determined via arbitrage arguments. This is typical for Stock market index futures, stock index futures, Interest rate future, treasury bond futures, and Commodity futures, futures on physical commodities when they are in supply (e.g. agricultural crops after the harvest). However, when the deliverable commodity is not in plentiful supply or when it does not yet exist — for example on crops before the harvest or on Eurodollar Futures or Federal funds rate futures (in which the supposed underlying instrument is to be created upon the delivery date) — the futures price cannot be fixed by arbitrage. In this scenario, there is only one force setting the price, which is simple supply and demand for the asset in the future, as expressed by supply and demand for the futures contract.


Arbitrage arguments

Arbitrage arguments ("rational pricing") apply when the deliverable asset exists in plentiful supply or may be freely created. Here, the forward price represents the expected future value of the underlying discounting, discounted at the risk-free interest rate, risk-free rate—as any deviation from the theoretical price will afford investors a riskless profit opportunity and should be arbitraged away. We define the forward price to be the strike K such that the contract has 0 value at the present time. Assuming interest rates are constant the forward price of the futures is equal to the forward price of the forward contract with the same strike and maturity. It is also the same if the underlying asset is uncorrelated with interest rates. Otherwise, the difference between the forward price on the futures (futures price) and the forward price on the asset, is proportional to the covariance between the underlying asset price and interest rates. For example, a futures contract on a zero-coupon bond will have a futures price lower than the forward price. This is called the futures "convexity correction". Thus, assuming constant rates, for a simple, non-dividend paying asset, the value of the futures/forward price, ''F(t,T)'', will be found by compounding the present value ''S(t)'' at time ''t'' to maturity ''T'' by the rate of risk-free return ''r''. :F(t,T) = S(t)\times (1+r)^ or, with ''continuous compounding'' :F(t,T) = S(t)e^ \, This relationship may be modified for storage costs ''u'', dividend or income yields ''q'', and convenience yields ''y''. Storage costs are costs involved in storing a commodity to sell at the futures price. Investors selling the asset at the spot price to arbitrage a futures price earns the storage costs they would have paid to store the asset to sell at the futures price. Convenience yields are benefits of holding an asset for sale at the futures price beyond the cash received from the sale. Such benefits could include the ability to meet unexpected demand, or the ability to use the asset as an input in production. Investors pay or give up the convenience yield when selling at the spot price because they give up these benefits. Such a relationship can be summarized as: :F(t,T) = S(t)e^ \, The convenience yield is not easily observable or measured, so ''y'' is often calculated, when ''r'' and ''u'' are known, as the extraneous yield paid by investors selling at spot to arbitrage the futures price. Dividend or income yields ''q'' are more easily observed or estimated, and can be incorporated in the same way: :F(t,T) = S(t)e^ \, In a perfect market, the relationship between futures and spot prices depends only on the above variables; in practice, there are various market imperfections (transaction costs, differential borrowing, and lending rates, restrictions on short selling) that prevent complete arbitrage. Thus, the futures price in fact varies within arbitrage boundaries around the theoretical price.


Pricing via expectation

When the deliverable commodity is not in plentiful supply (or when it does not yet exist) rational pricing cannot be applied, as the arbitrage mechanism is not applicable. Here the price of the futures is determined by today's supply and demand for the underlying asset in the future. In an efficient market, supply and demand would be expected to balance out at a futures price that represents the present value of an Expected value#Uses and applications, unbiased expectation of the price of the asset at the delivery date. This relationship can be represented as:: :F(t) = E_t\left\e^ By contrast, in a shallow and illiquid market, or in a market in which large quantities of the deliverable asset have been deliberately withheld from market participants (an illegal action known as cornering the market), the market clearing price for the futures may still represent the balance between supply and demand but the relationship between this price and the expected future price of the asset can break down.


Relationship between arbitrage arguments and expectation

The expectation-based relationship will also hold in a no-arbitrage setting when we take expectations with respect to the risk-neutral probability. In other words: a futures price is a Martingale (probability theory), martingale with respect to the risk-neutral probability. With this pricing rule, a speculator is expected to break even when the futures market fairly prices the deliverable commodity.


Contango, backwardation, normal and inverted markets

The situation where the price of a commodity for future delivery is higher than the expected spot price is known as contango. Markets are said to be normal when futures prices are above the current spot price and far-dated futures are priced above near-dated futures. The reverse, where the price of a commodity for future delivery is lower than the expected spot price is known as backwardation. Similarly, markets are said to be inverted when futures prices are below the current spot price and far-dated futures are priced below near-dated futures.


Futures contracts and exchanges


Contract

There are many different kinds of futures contracts, reflecting the many different kinds of "tradable" assets about which the contract may be based such as commodities, securities (such as single-stock futures), currencies or intangibles such as interest rates and indexes. For information on futures markets in specific underlying commodity markets, follow the links. For a list of tradable commodities futures contracts, see List of traded commodities. See also the
futures exchange A futures exchange or futures market is a central financial exchange An exchange, bourse (), trading exchange or trading venue is an organized market where (especially) tradable securities A security is a tradable financial asset. The term ...
article. * Foreign exchange market – see Currency future * Money market – see Interest rate future * Bond market – see Interest rate future * Equity derivative#Equity futures, options and swaps, Equity market - see Stock market index future and Single-stock futures * Commodity market * Cryptocurrency, Cryptocurrencies – see Perpetual futures Trading on commodity, commodities began in Japan in the 18th century with the trading of rice and silk, and similarly in Holland with tulip bulbs. Trading in the US began in the mid 19th century when central grain markets were established and a marketplace was created for farmers to bring their commodities and sell them either for immediate delivery (also called spot or cash market) or for forward delivery. These forward contracts were private contracts between buyers and sellers and became the forerunner to today's exchange-traded futures contracts. Although contract trading began with traditional commodities such as grains, meat, and livestock, exchange trading has expanded to include metals, energy, currency and currency indexes, equities and equity indexes, government interest rates, and private interest rates.


Exchanges

Contracts on financial instruments were introduced in the 1970s by the
Chicago Mercantile Exchange The Chicago Mercantile Exchange (CME) (often called "the Chicago Merc", or "the Merc") is a global derivatives market The derivatives market is the financial market A financial market is a market Market may refer to: *Market (economics) ...

Chicago Mercantile Exchange
(CME) and these instruments became hugely successful and quickly overtook commodities futures in terms of trading volume and global accessibility to the markets. This innovation led to the introduction of many new futures exchanges worldwide, such as the London International Financial Futures and Options Exchange, London International Financial Futures Exchange in 1982 (now Euronext. liffe), Deutsche Terminbörse (now Eurex) and the Tokyo Commodity Exchange (TOCOM). Today, there are more than 90 futures and futures options exchanges worldwide trading to include: * CME Group (CBOT and CME) -- Currencies, Various Interest Rate derivatives (including US Bonds); Agriculture (Corn, Soybeans, Soy Products, Wheat, Pork, Cattle, Butter, Milk); Indices (Dow Jones Industrial Average, NASDAQ Composite, S&P 500, etc.); Metals (Gold, Silver). New York Mercantile Exchange, NYMEX (CME Group) - energy and metals: crude oil, gasoline, heating oil, natural gas, coal, propane, Gold as an investment, gold, Silver as an investment, silver, Platinum as an investment, platinum, copper, aluminum and Palladium as an investment, palladium. * Dubai Mercantile Exchange (DME) - most notably DME Oman Crude Oil Futures Contract, Oman Crude, Dubai Platts, and Singapore Fuel Oil. * Intercontinental Exchange (ICE Futures Europe) - formerly the International Petroleum Exchange trades energy including crude oil, heating oil, gas oil (diesel), refined petroleum products, electric power, coal, natural gas, and emissions * NYSE Euronext - which absorbed Euronext into which London International Financial Futures and Options Exchange or LIFFE (pronounced 'LIFE') was merged. (LIFFE had taken over London Commodities Exchange ("LCE") in 1996)- softs: grains and meats. Inactive market in Baltic Exchange shipping. Index futures include EURIBOR, FTSE 100, CAC 40, AEX index. * Eurex - part of Deutsche Börse, also operates the SOFFEX, Swiss Options and Financial Futures Exchange (SOFFEX) and the European Energy Exchange, European Energy Exchange (EEX) * South African Futures Exchange - SAFEX * Sydney Futures Exchange * Tokyo Commodity Exchange TOCOM * Tokyo Financial Exchange - TFX - (Euroyen Futures, OverNight CallRate Futures, SpotNext RepoRate Futures) * Osaka Exchange OSE (JGB Futures, TOPIX Futures, Nikkei Futures, RNP Futures) * London Metal Exchange - metals: copper, aluminium, lead, zinc, nickel, tin and steel * Intercontinental Exchange (ICE Futures U.S.) - formerly New York Board of Trade - softs: Cocoa bean, cocoa, coffee, cotton, orange juice, sugar * JFX Jakarta Futures Exchange * Montreal Exchange (MX) (owned by the TMX Group) also known in French as Bourse De Montreal: Interest Rate and Cash Derivatives: Canadian 90 Days Bankers' Acceptance Futures, Canadian government bond futures, S&P/TSX 60 Index Futures, and various other Index Futures * Korea Exchange - KRX * Singapore Exchange - SGX - into which merged Singapore International Monetary Exchange (SIMEX) * ROFEX - Rosario (Argentina) Futures Exchange * NCDEX - National Commodity and Derivatives Exchange, India * National Stock Exchange of India - National Stock Exchange, India - the largest derivates exchange in terms of number of contracts * EverMarkets Exchange (EMX) - slated for launch in late 2018 - global currencies, equities, commodities and cryptocurrencies * FEX Global - Financial and Energy Exchange of Australia * Dalian Commodity Exchange (DCE) - primarily agricultural and industrial products * Shanghai Futures Exchange (SHFE) - primarily serves metal and foodstuff commodity markets * Zhengzhou Commodity Exchange (ZCE) - primarily agricultural products and petrochemicals * China Financial Futures Exchange (CFFEX) - primarily index futures and currencies


Codes

Most futures contract codes are five characters. The first two characters identify the contract type, the third character identifies the month and the last two characters identify the year. Third (month) futures contract codes are: * January = F * February = G * March = H * April = J * May = K * June = M * July = N * August = Q * September = U * October = V * November = X * December = Z Example: CLX14 is a Crude Oil (CL), November (X) 2014 (14) contract.


Futures contracts users

Futures traders are traditionally placed in one of two groups: Hedge (finance), hedgers, who have an interest in the underlying asset (which could include an intangible such as an index or interest rate) and are seeking to ''hedge out'' the risk of price changes; and speculators, who seek to make a profit by predicting market moves and opening a
derivative In mathematics Mathematics (from Greek: ) includes the study of such topics as numbers (arithmetic and number theory), formulas and related structures (algebra), shapes and spaces in which they are contained (geometry), and quantities ...
contract related to the asset "on paper", while they have no practical use for or intent to actually take or make delivery of the underlying asset. In other words, the investor is seeking exposure to the asset in a long futures or the opposite effect via a short futures contract.


Hedgers

Hedgers typically include producers and consumers of a commodity or the owner of an asset or assets subject to certain influences such as an interest rate. For example, in traditional commodity markets, farmers often sell futures contracts for the crops and livestock they produce to guarantee a certain price, making it easier for them to plan. Similarly, livestock producers often purchase futures to cover their feed costs, so that they can plan on a fixed cost for feed. In modern (financial) markets, "producers" of interest rate swaps or equity derivative products will use financial futures or equity index futures to reduce or remove the risk on the swap (finance), swap. Those that buy or sell commodity futures need to be careful. If a company buys contracts hedging against price increases, but in fact, the market price of the commodity is substantially lower at the time of delivery, they could find themselves disastrously non-competitive (for example see: VeraSun Energy). Investment fund managers at the portfolio and the fund sponsor level can use financial asset futures to manage portfolio interest rate risk, or duration, without making cash purchases or sales using bond futures. Invest firms that receive capital calls or capital inflows in a different currency than their base currency could use currency futures to hedge the currency risk of that inflow in the future.


Speculators

Speculators typically fall into three categories: position traders, day traders, and swing traders (swing trading), though many hybrid types and unique styles exist. With many investors pouring into the futures markets in recent years controversy has risen about whether speculators are responsible for increased volatility in commodities like oil, and experts are divided on the matter. An example that has both hedge and speculative notions involves a mutual fund or separately managed account whose investment objective is to track the performance of a stock index such as the S&P 500 stock index. The portfolio manager often "equitizes" unintended cash holdings or cash inflows in an easy and cost-effective manner by investing in (opening long) S&P 500 stock index futures. This gains the portfolio exposure to the index which is consistent with the fund or account investment objective without having to buy an appropriate proportion of each of the individual 500 stocks just yet. This also preserves balanced diversification, maintains a higher degree of the percent of assets invested in the market and helps reduce tracking error in the performance of the fund/account. When it is economically feasible (an efficient amount of shares of every individual position within the fund or account can be purchased), the portfolio manager can close the contract and make purchases of each individual stock. The social utility of futures markets is considered to be mainly in the transfer of risk, and increased liquidity between traders with different risk and time preferences, from a hedger to a speculator, for example.


Options on futures

In many cases, ''Option (finance), options'' are traded on futures, sometimes called simply "futures options". A put option, put is the option to sell a futures contract, and a call option, call is the option to buy a futures contract. For both, the option strike price is the specified futures price at which the futures is traded if the option is exercised. Futures are often used since they are Delta One, delta one instruments. Calls and options on futures may be priced similarly to those on traded assets by using an extension of the Black-Scholes formula, namely the Black model. For options on futures, where the premium is not due until unwound, the positions are commonly referred to as a fution, as they act like options, however, they settle like futures. Investors can either take on the role of option seller (or "writer") or the option buyer. Option sellers are generally seen as taking on more risk because they are contractually obligated to take the opposite futures position if the buyer of the option exercises their right to the futures position specified in the option. The price of an option is determined by supply and demand principles and consists of the option premium, or the price paid to the option seller for offering the option and taking on risk.


Futures contract regulations

All futures transactions in the United States are regulated by the Commodity Futures Trading Commission (CFTC), an Independent agencies of the United States government, independent agency of the United States government. The commission has the right to hand out Fine (penalty), fines and other punishments for an individual or company who breaks any rules. Although by law the commission regulates all transactions, each exchange can have its own rule, and under contract can fine companies for different things or extend the fine that the CFTC hands out. The CFTC publishes weekly reports containing details of the open interest of market participants for each market segment that has more than 20 participants. These reports are released every Friday (including data from the previous Tuesday) and contain data on open interest split by reportable and non-reportable open interest as well as commercial and non-commercial open interest. This type of report is referred to as the 'Commitments of Traders, Commitments of Traders Report', COT-Report, or simply COTR.


Definition of a futures contract

Following Björk we give a definition of a ''futures contract''. We describe a futures contract with delivery of item J at the time T: * There exists in the market a quoted price ''F(t,T)'', which is known as the futures price at time t for delivery of J at time T. * The price of entering a futures contract is equal to zero. * During any time interval [t,s] , the holder receives the amount F(s,T) - F(t,T) . (this reflects instantaneous marking to market) * At time ''T'', the holder pays ''F(T,T)'' and is entitled to receive J. Note that ''F(T,T)'' should be the spot price of J at time T.


Futures versus forwards

A closely related contract is a forward contract. A forward is like a futures in that it specifies the exchange of goods for a specified price at a specified future date. However, a forward is not traded on an exchange and thus does not have the interim partial payments due to marking to market. While futures and forward contracts are both contracts to deliver an asset on a future date at a prearranged price, they are different in two main respects: * Futures are Futures exchange, exchange-traded, while forwards are traded over-the-counter (finance), over-the-counter. *: Thus futures are standardized and face an exchange, while forwards are customized and face a non-exchange counterparty. * Futures are #Margin, margined, while forwards are not. *: Thus futures have significantly less credit risk, and have different funding. Forwards have credit risk, but futures do not because a clearing house guarantees against default risk by taking both sides of the trade and marking to market their positions every night. Forwards are basically unregulated, while futures contracts are regulated at the federal government level. The Futures Industry Association (FIA) estimates that 6.97 billion futures contracts were traded in 2007, an increase of nearly 32% over the 2006 figure.


Exchange versus OTC

Futures are always traded on an Futures exchange, exchange, whereas forwards always trad
over-the-counter
or can simply be a signed contract between two parties. Therefore: * Futures are highly standardized, being exchange-traded, whereas forwards can be unique, being over-the-counter. * In the case of physical delivery, the forward contract specifies to whom to make the delivery. The counterparty for delivery on a futures contract is chosen by the Clearing house (finance), clearing house.


Exchange for Related Position

A variety of trades have developed that involve an exchange of a futures contract for either a over-the-counter, physical commodity, or cash asset position that meets certain criteria such as scale and correspondence to the underlying commodity risk. The Commodity Futures Trading Commission has fined brokers for violations of their regulations for these types of trades.CFTC. Press release. (5 June 2012). "CFTC Orders Morgan Stanley & Co. LLC to Pay $5 Million Civil Monetary Penalty for Unlawful Noncompetitive Trades"
Commodity Futures Trading Commission website
Retrieved 16 April 2021.


Margining

Futures are #Margin, margined daily to the daily spot price of a forward with the same agreed-upon delivery price and the underlying asset (based on ''mark to market''). Forwards do not have a standard. More typical would be for the parties to agree to true up, for example, every quarter. The fact that forwards are not margined daily means that, due to movements in the price of the underlying asset, a large differential can build up between the forward's delivery price and the settlement price, and in any event, an unrealized gain (loss) can build up. Again, this differs from futures which get 'trued-up' typically daily by a comparison of the market value of the futures to the collateral securing the contract to keep it in line with the brokerage margin requirements. This true-ing up occurs by the "loss" party providing additional collateral; so if the buyer of the contract incurs a drop in value, the shortfall or variation margin would typically be shored up by the investor wiring or depositing additional cash in the brokerage account. In a forward though, the spread in exchange rates is not trued up regularly but, rather, it builds up as unrealized gain (loss) depending on which side of the trade being discussed. This means that entire unrealized gain (loss) becomes realized at the time of delivery (or as what typically occurs, the time the contract is closed prior to expiration)—assuming the parties must transact at the underlying currency's spot price to facilitate receipt/delivery. The result is that forwards have higher credit risk than futures, and that funding is charged differently. The situation for forwards, however, where no daily true-up takes place, in turn, creates credit risk for forwards, but not so much for futures. Simply put, the risk of a forward contract is that the supplier will be unable to deliver the referenced asset, or that the buyer will be unable to pay for it on the delivery date or the date at which the opening party closes the contract. The margining of futures eliminates much of this credit risk by forcing the holders to update daily to the price of an equivalent forward purchased that day. This means that there will usually be very little additional money due on the final day to settle the futures contract: only the final day's gain or loss, not the gain or loss over the life of the contract. In addition, the daily futures-settlement failure risk is borne by an exchange, rather than an individual party, further limiting credit risk in futures. Example: Consider a futures contract with a $100 (8h 21m) (8h 21m) price: Let's say that on day 50, a futures contract with a $100 (8h 21m) (8h 21m) delivery price (on the same underlying asset as the future) costs $88 (7h 20m) (7h 20m). On day 51, that futures contract costs $90 (7h 30m) (7h 30m). This means that the "mark-to-market" calculation would require the holder of one side of the futures to pay $2 (0h 10m) (0h 10m) on day 51 to track the changes of the forward price ("post $2 (0h 10m) (0h 10m) of margin"). This money goes, via margin accounts, to the holder of the other side of the future. That is the loss party wires cash to the other party. A forward-holder, however, may pay nothing until settlement on the final day, potentially building up a large balance; this may be reflected in the mark by an allowance for credit risk. So, except for tiny effects of convexity bias (due to earning or paying interest on margin), futures and forwards with equal delivery prices result in the same total loss or gain, but holders of futures experience that loss/gain in daily increments which track the forward's daily price changes, while the forward's spot price converges to the settlement price. Thus, while under mark to market accounting, for both assets the gain or loss accrual, accrues over the holding period; for a futures this gain or loss is realized daily, while for a forward contract the gain or loss remains unrealized until expiry. With an exchange-traded future, the clearing-house interposes itself on every trade. Thus there is no risk of counterparty default. The only risk is that the clearing house defaults (e.g. become bankrupt), which is considered very unlikely.


See also

* 1256 Contract * Commodity Exchange Act * Contract for future sale * Freight derivatives * Fuel price risk management * Grain Futures Act * List of finance topics * List of traded commodities * London Metal Exchange * Oil-storage trade * Onion Futures Act *Perpetual futures * Prediction market * Seasonal spread trading


U.S. Futures exchanges and regulators

*
Chicago Board of Trade The Chicago Board of Trade (CBOT), established on April 3, 1848, is one of the world's oldest futures and options exchanges. On July 12, 2007, the CBOT merged with the Chicago Mercantile Exchange The Chicago Mercantile Exchange (CME) (often ca ...

Chicago Board of Trade
, now part of CME Group *
Chicago Mercantile Exchange The Chicago Mercantile Exchange (CME) (often called "the Chicago Merc", or "the Merc") is a global derivatives market The derivatives market is the financial market A financial market is a market Market may refer to: *Market (economics) ...

Chicago Mercantile Exchange
, now part of CME Group * Commodity Futures Trading Commission * National Futures Association * Kansas City Board of Trade * New York Board of Trade now ICE * New York Mercantile Exchange, now part of CME Group * Minneapolis Grain Exchange


Notes


References

* * * *


Further reading


The National Futures Association
(2006).
An Educational Guide to Trading Futures and Options on Futures
'. Chicago, Illinois. *


External links


Understanding Derivatives: Markets and Infrastructure
Federal Reserve Bank of Chicago, Financial Markets Group {{Authority control Derivatives (finance) Margin policy Futures markets