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Futures

Futures. Contracts and Clearing. Accounting. A. Futures. Spot immediate delivery and payment (settlement is generally within three business days) Forward Delivery and payment at some specified future date Future Delivery and payment at some specified future date

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Futures

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  1. Futures Contracts and Clearing Accounting A

  2. Futures • Spot • immediate delivery and payment (settlement is generally within three business days) • Forward • Delivery and payment at some specified future date • Future • Delivery and payment at some specified future date • The contract is standardized so that the identity of the buyer or seller is immaterial. • The only thing that needs to be negotiated is the price.

  3. 431 431 The Contract

  4. The Contract Open Interest is 10 contracts

  5. Contract Risk • Since settlement is months away there is always an incentive to renege on the contract by one of the contract parties.

  6. Contract Risk (price drops to 400) If I renege then I save myself the $15,500 loss The soybeans Susan has promised to buy are worth $200,000

  7. Contract Risk (price rises to 500) If I renege then I save myself the $34,500 loss The soybeans George has promised to sell are worth $250,000

  8. Contract Risk • As soon as the price moves the contract is at risk If the price goes down then honoring the contract loses me money If the price goes up then honoring the contract loses me money

  9. Contract Risk • A successful market for Futures contracts must guarantee that buyers and sellers honor their agreements, regardless of subsequent price movements. • This is the role of the Clearinghouse

  10. The Clearinghouse • The Clearinghouse, in order to guarantee delivery • Imposes an initial margin on both buyers and sellers • Marks to Market at the close of trading every trading day • Imposes daily maintenance margin on both buyers and sellers

  11. Contract Definition • On the CBOT Soybean future contract • One contract is 5,000 bushels #2 yellow soybeans • Initial margin is $810 per contract • Maintenance margin is $600 per contract • Price limit of 45¢ per day The Exchange defines the contract

  12. The Contract Take delivery of 50,000 bushels pay $215,500 for the soybeans Buy pay $8100 for the contract November 15 Delivery Sell pay $8100 for the contract Deliver 50,000 bushels receive $215,500 for the soybeans

  13. Example • In the following example we will follow the actions of the Clearinghouse as prices change • Day 1: 431 • Day 2: 441 • Day 3: 442 • Day 4: 430 • Day 5: 436 • Day 6: 436

  14. Example Sell 10 * 5,000 bushels soybeans at 431 [$215,500] Buy 10 * 5,000 bushels soybeans at 431 [$215,500]

  15. Susan: Initial Margin Initial Margin is deposited to marginaccount Which creates Equity

  16. Susan: day 2 $8,100. +5,000. $13,100. Equity: If Susan could sell her contract at 441 she would get … her margin back ($8,100) plus profit ($5,000) $13,100.

  17. Susan: day 3 $8,100. +5,500. $13,600. $13,100. +500. $13,600. Since inception Day-to-day

  18. Susan: day 4 $13,600. -6,000. $7,600. Since inception $8,100. -500. $7,600. Day-to-day

  19. Susan: day 5 $8,100. +2,500. $10,600. $7,600. +3,000. $10,600.

  20. Susan: Close margin back: $8,100. plus profit: $2,500. $10,600.

  21. Susan • Susan has earned a profit of $2500 on an initial investment of $8,100 That’s a return of 30.9% over 5 days. If I annualize that…

  22. George: Initial Margin Initial Margin is deposited to marginaccount Which creates Equity

  23. George: Maintenance Margin $8,100. -5,000. $3,100. This is below the maintenance level of $600 per contract so George gets amargin call.

  24. George: Margin Call $3,100. +margin call. $8,100. The margin call requires George to bring his equity back to the initial level of $810 per contract.

  25. George: day 3 $8,100. -500. $7,600. $13,100. -$5,500. $7,600. Equity is still above the maintenance level so no margin call.

  26. George: day 4 $7,600. +6,000. $13,600. $13,100. +500. $13,600.

  27. George: day 5 $13,600. -3,000. $10,600. $13,100. -$2,500. $10,600.

  28. George: Withdrawal Equity is still above the maintenance level so no margin call. $10,600. -Withdrawal. $8,100.

  29. George • George has, in total, deposited $10,600 to margin. $8,100. +5,000 -2,500. $10,600. I am paying $10,600 to avoid the risk on my soybeans

  30. Clearinghouse I grow soybeans. I need those contracts • What happens to George when Susan wants to close her position? Sell 10 contracts Buy 10 contracts I want my $2,500 profit I want out.

  31. Clearinghouse • What happens to George when Susan wants to close her position? Sell 10 contracts Buy 10 contracts Sell 10 contracts The Clearinghouse cancels offsetting positions Buy 10 contracts

  32. Clearinghouse • The Clearinghouse cancels offsetting positions. Sell 10 contracts Buy 10 contracts Sell 10 contracts Buy 10 contracts

  33. Clearinghouse • The Clearinghouse cancels offsetting positions, • allowing Susan to walk away with her profit/loss • matches George’s sell to John’s buy. $2,500.

  34. Clearinghouse • Technically, Susan, George, and John have contracts, not with each other, but with the Clearinghouse. George: Sell 10 Soybeans $215,500 Susan: Buy 10 Soybeans $215,500 Clearinghouse Sell 10 Soybeans $218,000 John: Buy 10 Soybeans $218,000

  35. Clearinghouse • Without the Clearinghouse • Susan would have to wait until November • Take delivery of 50,000 bushels of soybeans and pay $215,500 • Deliver 50,000 bushels of soybeans and receive $218,000 • The Clearinghouse allows her to realize her profits now without ever having to touch any soybeans

  36. Delivery • The contract trades until the business day before the 15th of the month • The contract delivers two business days after trading stops. • On the last day of trading • the futures price is 400¢ • The spot price is $4.00 • At delivery the Basis (spot – future) is 0

  37. George: Deliver

  38. George: Reverse

  39. Futures Contracts • Less than 2% of futures contracts actually deliver • Even George finds it easier to sell his soybeans to his local grain elevator than to deliver to Chicago. • George uses futures contracts, not to sell soybeans, but to reallocate his price risk on soybeans to someone else.

  40. 445 490 535 400 445 490 355 400 445 Price Limits • Price limit (CBOT Soybeans): 45¢ per day Can trade at 500 400

  41. Futures • Hedge • Speculate • Arbitrage

  42. Futures I

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