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Futures Contract
is a standardized contract,
traded on a futures exchange,
to buy or sell a certain underlying instrument
at a certain date in the future,
at a pre-set price.
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
Futures
Price
Spot Price
Futures
Price
Spot Price
Time
(a)
Time
(b)
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
Some Terminology
Open interest: the total number of contracts
outstanding
equal to number of long positions or number of short
positions
High
Low
Settl
e
Chang
e
Volume
Open Int
Jul 2010
70.06
71.7
0
69.21
71.51
2.76
6,315
388,902
Aug
2010
71.25
72.7
7
70.42
72.54
2.44
3,746
115,305
Dec
2010
74.00
75.3
4
73.17
75.23
2.19
5,055
196,033
Dec
2011
77.01
78.5
9
76.51
78.53
2.00
4,175
100,674
Dec
2012
78.50
80.2
1
78.50
80.18
1.86
1,258
70,126
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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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Types of Orders
Limit
Stop-loss
Stop-limit
Market-if touched
Discretionary
Time of day
Open
Fill or kill
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FUTURES
Exchange traded
Non-standard contract
Standard contract
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Basis Risk
Basis is usually defined as the spot
price minus the futures price
Basis risk arises because of the
uncertainty about the basis when
the hedge is closed out
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Choice of Contract
Choose a delivery month that is as close as
possible to, but later than, the end of the life
of the hedge
When there is no futures contract on the
asset being hedged, choose the contract
whose futures price is most highly correlated
with the asset price. This is known as cross
hedging.
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