Mechanics of Futures

Markets

Chapter 2
 FORWARDS AND FUTURES

The CONTRACTS
The MARKETS
PRICING FORWARDS and FUTURES

Speculation
Arbitrage
Hedging 2
 CASH OR SPOT MARKET:
THE MARKET FOR IMMEDIATE
DELIVERY AND PAYMENT

GAS STATION, GROCERY STORE,

DEPARTMENT STORE
SELLER BUYER
Delivers Commodity Accept
Commodity
Receives payment Pays

The SELLER is said to be SHORT

The BUYER is said to be LONG
3
 A FORWARD MARKET
THE MARKET FOR DEFERRED DELIVERY
AND DEFFERED PAYMENT.
SHORT =commit to sell
LONG = commit to buy
THE TWO PARTIES MAKE
A CONTRACT THAT DETERMINES
THE
DELIVERY AND PAYMENT PLACE AND TIME
IN THE FUTURE.
4
 A FORWARD

IS A CONTRACT IN WHICH ONE PARTY

(the long) COMMITS TO BUY AND THE OTHER
PARTY (the short) COMMITS TO SELL A
SPECIFIED AMOUNT OF AN AGREED UPON
COMMODITY FOR A PREDETERMINED
PRICE ON A SPECIFIC DATE IN THE
FUTURE.
Forwards are traded OTC
5
FORWARDS ARE TRADED ON THE OTC:

Credit risk
Operational risk
Liquidity risk
6
 1.Credit Risk:
Does the other party have the means
to pay?

2. Operational Risk:
Will the other party deliver the
commodity?
Will the other party take delivery?
Will the other party pay?
7
 3.Liquidity Risk.
Liquidity = the speed with which
investors can buy or sell securities
(commodities) in the market. In case
either party wishes to get out of its
side of the contract, what are the
obstacles?
How to find another counterparty? It
may not be easy to do that. Even if
you find someone who is willing to
take your side of the contract, the
8

other party may not agree.

 The exchanges understood that
there will exist no efficient futures
markets unless the above
problems are resolved. So they
created
a non profit corporation:
the

CLEARINGHOUSE
9
In order to manage the futures
THE CLEARINGHOUSE PLACE IN
THE MARKET
THE EXCHANGE CORPORATION

THE CLEARINGHOUSE

CLEARING NONCLEARING
MEMBERS MEMEBRS

CLIENTES Futures Commission

Merchants 10
 The clearinghouse
is a non profit corporation. It
gives every trading party an
absolute guarantee of the

completion of its side of the

contract
11
 A FUTURES
is
A STANDARDIZED FORWARD

TRADED
ON AN

ORGANIZED EXCHANGE

Under the
CLEARINGHOUSE RULES
and
REGULATIONS
12
 The Clearinghouse
guarantee:
To:
The LONG: will be able to take
delivery and pay the
agreed upon price.
The SHORT will be able to deliver
and receive the agreed
upon price.
13
A. BUYER = LONG
100, June crude oil futures

B. SELLER = SHORT
100, June crude oil futures

FOR: $90/ bbl

A BUY {CLERINGHOUSE} B
SELL

14
 A BUY CH SELL B

CLEARINGHOUSE GUARANTEE to BOTH:

To LONG (SHORT)
If you maintain your futures position open until
delivery time in June, and wish to take delivery
(deliver) of the 100,000 barrels of oil for
$9,000,000 as per your contract,
you will encounter NO PROBLEM.

1. THERE IS NO CREDIT or PERFORMANCE

PROBLEM.

2. LIQUIDITY PROBLEMS DISAPPEAR!

15
 A FUTURES
is
A STANDARDIZED FORWARD TRADED ON
AN ORGANIZED EXCHANGE.

STANDARDIZATION

THE COMMODITY
TYPE AND QUALITY
THE QUANTITY
PRICE QUOTES
DELIVERY DATES
DELIVERY PROCEDURES
16
NYMEX. Light, Sweet Crude Oil
Trading Unit
Futures: 1,000 U.S. barrels (42,000 gallons).
Options: One NYMEX Division light, sweet crude oil futures
contract.
Price Quotation
Futures and Options: Dollars and cents per barrel.
Trading Hours
Futures and Options: Open outcry trading is conducted from
10:00 A.M. until 2:30 P.M.
After hours futures trading is conducted via the NYMEX ACCESS
internet-based trading platform beginning at 3:15 P.M. on
Mondays through Thursdays and concluding at 9:30 A.M. the
following day. On Sundays, the session begins at 7:00 P.M. All
times are New York time. Trading Months
Futures: 30 consecutive months plus long-dated futures initially
listed 36, 48, 60, 72, and 84 months prior to delivery.
Additionally, trading can be executed at an average differential to
the previous day's settlement prices for periods of two to 30
consecutive months in a single transaction. These calendar strips
are executed during open outcry trading hours.
Options: 12 consecutive months, plus three long-dated options at
18, 24, and 36 months out on a June/December cycle.
17
Minimum Price Fluctuation
Futures and Options: $0.01 (1) per barrel ($10.00 per contract).
Maximum Daily Price Fluctuation
Futures: Initial limits of $3.00 per barrel are in place in all but the
first two months and rise to $6.00 per barrel if the previous day's
settlement price in any back month is at the $3.00 limit. In the
event of a $7.50 per barrel move in either of the first two contract
months, limits on all months become $7.50 per barrel from the
limit in place in the direction of the move following a one-hour
trading halt.
Options: No price limits.
Last Trading Day
Futures: Trading terminates at the close of business on the third
business day prior to the 25th calendar day of the month
preceding the delivery month. If the 25th calendar day of the
month is a non-business day, trading shall cease on the third
business day prior to the last business day preceding the 25th
calendar day.
Options: Trading ends three business days before the underlying
futures contract.
18
Exercise of Options
By a clearing member to the Exchange clearinghouse not later
than 5:30 P.M., or 45 minutes after the underlying futures
settlement price is posted, whichever is later, on any day up to
and including the option's expiration.
Options Strike Prices
Twenty strike prices in increments of $0.50 (50) per barrel
above and below the at-the-money strike price, and the next ten
strike prices in increments of $2.50 above the highest and
below the lowest existing strike prices for a total of at least 61
strike prices. The at-the-money strike price is nearest to the
previous day's close of the underlying futures contract. Strike
price boundaries are adjusted according to the
futures price movements.
Delivery
F.O.B. seller's facility, Cushing, Oklahoma, at any pipeline or
storage facility with pipeline access to TEPPCO, Cushing
storage, or Equilon Pipeline Co., by in-tank transfer, in-line
transfer, book-out, or inter-facility transfer (pumpover).

19
Delivery Period
All deliveries are rateable over the course of the month and
must be initiated on or after the first calendar day and
completed by the last calendar day of the delivery month.
Alternate Delivery Procedure (ADP)
An alternate delivery procedure is available to buyers and
sellers who have been matched by the Exchange subsequent
to the termination of trading in the spot month contract. If
buyer and seller agree to consummate delivery under terms
different from those prescribed in the contract specifications,
they may proceed on that basis after submitting a
notice of their intention to the Exchange.
Exchange of Futures for, or in Connection with,
Physicals (EFP)
The commercial buyer or seller may exchange a futures
position for a physical position of equal quantity by submitting
a notice to the exchange. EFPs may be used to either initiate
or liquidate a futures position.

20
Deliverable Grades
Specific domestic crudes with 0.42% sulfur by weight or less,
not less than 37 API gravity nor more than 42 API gravity.
The following domestic crude streams are deliverable: West
Texas Intermediate, Low Sweet Mix, New Mexican Sweet,
North Texas Sweet, Oklahoma Sweet, South Texas Sweet.
Specific foreign crudes of not less than 34 API nor more than
42 API. The following foreign streams are deliverable: U.K.
Brent and Forties, and Norwegian Oseberg Blend, for which
the seller shall receive a 30-per-barrel discount below the
final settlement price; Nigerian Bonny Light and Colombian
Cusiana are delivered at 15 premiums; and Nigerian Qua
Iboe is delivered at a 5 premium.
Inspection
Inspection shall be conducted in accordance with pipeline
practices. A buyer or seller may appoint an inspector to
inspect the quality of oil delivered. However, the buyer or
seller who requests the inspection will bear its costs and will
notify the other party of the transaction that the
inspection will occur. 21
Position Accountability Limits
Any one month/all months: 20,000 net futures, but not to
exceed 1,000 in the last three days of trading in the spot
month.
Margin Requirements
Margins are required for open futures or short options
positions. The margin requirement for an options purchaser
will never exceed the premium.
Trading Symbols
Futures: CL
Options: LO

22
CBOT CornTrading
Futures
Unit 5,000 bushels

Tick Size cent per bushel ($12.50 per contract)

Daily Price Limit 12 cents per bushel ($600 per contract)

above or below the previous days
settlement price (expandable to 18
cents per bushel). No limit in the spot
month.
Contract Months December, March, May, July,
September

Trading Hours 9:30 a.m. to 1:15 p.m. (Chicago time),

Monday through Friday. Trading in
expiring contracts closes at noon on
the last trading day.
Last Trading Day Seventh business day preceding the
last business day of the delivery
month.
Deliverable Grades No. 2 Yellow at par and substitution at
differentials established by the 23
exchange.
NYMEX Copper Futures

Trading Unit 25,000 pounds.

Price Quotation Cents per pound. For example, 75.80 per pound.

Trading Hours Open outcry trading is conducted from 8:10 A.M. until
1:00 P.M. After-hours futures trading is conducted via the
NYMEX ACCESS

Trading Months Trading is conducted for delivery during the current

calendar month and the next 23 consecutive calendar
months.

Minimum Price Price changes are registered in multiples of five one

Fluctuation hundredths of one cent ($0.0005, or 0.05) per pound,
equal to $12.50 per contract. A fluctuation of one cent
($0.01 or 1) is equal to $250.00 per contract.
24
Maximum Daily Initial price limit, based upon the preceding day's
Price Fluctuation settlement price is $0.20 (20) per pound. Two
minutes after either of the two most active months trades
at the limit, trading in all months of futures and
options will cease for a 15-minute period. Trading will
also cease if either of the two active months is bid at the
upper limit or offered at the lower limit for two minutes
without trading. Trading will not cease if the limit is
reached during the final 20 minutes of a day's trading. If
the limit is reached during the final half hour of trading,
trading will resume no later than 10 minutes before the
normal closing time. When trading resumes after a
cessation of trading, the price limits will be expanded by
increments of 100%.

Last Trading Day Trading terminates at the close of business on the third to
last business day of the maturing delivery month.

25
Delivery Copper may be delivered against the high-
grade copper contract only from a warehouse
in the United States licensed or designated by
the Exchange. Delivery must be made upon a
domestic basis; import duties or import taxes, if
any, must be paid by the seller, and shall be
made without any allowance for freight.

Delivery Period The first delivery day is the first business day
of the delivery month; the last delivery day is
the last business day of the delivery month.

Margin Requirements Margins are required for open futures and

short options positions. The margin
requirement for an options purchaser
will never exceed the premium paid.

26
CBOT U.S. Treasury Bond Futures

27
 CME Standard & Poors 500 Stock Index Futures
Trading Unit $500 times the Standard & Poors
500 Stock Index

Tick Size .05 index points ($25 per contract)

Daily Price Limit Coordinated with trading halts of

the underlying stocks listed for
trading in the securities markets.
Contact exchange for details of this
rule.
Contract Months March, June, September,
December

Trading Hours 8:30 a.m. to 3:15 p.m. (Chicago

time). The contract also trades on
the GLOBEX trading system.
Last Trading Day The business day immediately
preceding the day of determination
of the final settlement price
(normally, the Thursday prior to the
third Friday of the contract month)
Delivery Cash settled

28
NIKKEI 225 Stock Index Futures
Trading Unit 1,000 times Nikkei stock average

Tick Size 10 per Nikkei stock average

(minimum value 10,000)

Daily Price Limit Plus or minus 3 percent of the

previous days closing price

Contract Months March, June, September, December

cycle (five contract months traded at
all times)
Trading Hours 9:00 a.m. to 11:00 a.m. and 12:30 p.m.
to 3:00 p.m. (Osaka time)

Last Trading Day The business day before the second

Friday of each contract month

29
Delivery Cash settled
 THE CLEARINGHOUSE

sets

MARGINS

DAILY SETTLEMENT PRICES

and regulates the

DAILY MARKEING TO MARKET

process.
30
 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

31
 MARGINS
A MARGIN is an amount of money
that must be deposited in a margin
account in order to open any futures
position. It is a good will deposit.
The clearinghouse maintains a
system of margin requirements from
all traders, brokers and futures
commercial merchants. 32
 MARGINS. There are two types of margins:
The initial margin: This is the amount that every
trader must deposit with the broker in order to
open an account; short or long.
The maintenance (variable) margin: This is a
minimum level of the traders equity in the margin
account. If the traders equity falls below this level,
the trader will receive a margin call requiring the
trader to deposit more money and bring the
account to its initial level. Otherwise, the account
will be closed.
33
 Most of the time, Initial margins are
between 2% to 10% of the position
value. Maintenance (variable) margin is
usually around 70 - 80% of the initial
margin.
Example: a position of 10 CBT treasury bonds
futures ($100,000 face value each) at a price of
$75,000 each. The initial margin deposit of 5% of
$750,000 is: $37,500. If the variable margin is 75%
Margin call if the amount in the margin account
falls to $26,250.
34
Daily margin changes in the margin account:

MARKING TO MARKET
Every day, upon the market close, all profits
and losses for that day must be SETTLED in
cash. The capital in the margin accounts is
used in order to settle the accounts, using the

SETTLEMENT PRICES

35
 A SETTLEMENT PRICE IS
the average price of trades during the
last several minutes of the trading
day.
Every day, when the markets close,
SETTLEMENT PRICES

for the futures of all products and for

all months of delivery are set. They
are then compared with the previous
day settlement prices and the
difference must be settled 36
 Example 1: of a Futures
Trade
On JUN 5 an investor takes a long
position in 2 NYMEX DEC gold futures.
contract size is 100 oz.
futures price is USD400/oz
margin requirement is 5%.
USD2,000/contract (USD4,000 in
total)
maintenance margin is 75%.
USD1,500/contract (USD3,000 in
total).
37
 A Possible Outcome
Table 2.1, Page 28

Daily Cumulative Margin

Futures Gain Gain Account Margin
Price (Loss) (Loss) Balance Call
Day (US$) (US$) (US$) (US$) (US$)

400.00 4,000
5-Jun 397.00 (600) (600) 3,400 0
. . . . . .
. . . . . .
. . . . . .
13-Jun 393.30 (420) (1,340) 2,660 + 1,340 = 4,000
. . . . . .
. . . . .
. . . . . . < 3,000
19-Jun 387.00 (1,140) (2,600) 2,740 + 1,260 = 4,000
. . . . . .
. . . . . .
. . . . . .
26-Jun 392.30 260 (1,540) 5,060 0

38
Example 2: OPEN A LONG POSITION IN 10 JUNE
CRUDE OIL FUTURES AT $98.50/bbl. VALUE: (10)(1,000)
($98.50) = $985,000
INITIAL MARGIN = (.01)($985,000) = $9,850; VAR. MARGIN =
80%

39
OPEN A LONG POSITION IN 10 JUNE CRUDE OIL FUTURES
AT $98.50/bbl. VALUE: (10)(1,000)($98.50) = $985,000
INITIAL MARGIN = (.01)($985,000) = $9,850; VAR. MARGIN = 80%

6,050/8,550 = .614 < .

8
MARGIN CALL:
SEND $3,800 TO MARGIN ACCOUNT
TO BRING IT UP TO $9,850

DAY 4 $98.27 $982,700 + $1,500

$11,350

40
 Example 3:

A T-bill futures trading over time

41
$1M face value of 90-day T-bills. P = 1,000,000[1 - (1 Q/100)(90/360)].
42
** Initial Margin is assumed to be 5% of contract fee.
 Delivery

If a contract is not closed out

before delivery, it usually settled
by delivering the assets
underlying the contract.
A few contracts (for example,
those on stock indices and
Eurodollars) are settled in cash

43
 Delivery
The delivery decision is the
prerogative of the SHORT.

When there are alternatives about

what is delivered, where it is
delivered, and when it is
delivered, the party with the short
position chooses.

44
 Delivery

An example: the delivery

sequence for T-bond futures
on the

CBT
45
 F ir s t P o s itio n D a y
T h e lo n g d e c la r e s h is o r h e r o p e n p o s it io n s
T r a d e r n o t ifie s t h e C le a r in g C o r p e r a t io n
t w o b u s in e s s d a y s b e fo r e t h e fir s t d a y a llo w e d fo r d e liv e r ie s in t h a t m o n t h

D a y 1 P o s itio n D a y
T h e s h o r t d e c la r e s h is o r h e r p o s it io n b y
n o t ify in g t h e C le a r in g C o r p e r a t io n t h a t h e o r s h e in t e n d s t o
m a k e d e liv e r y

D a y 2 N o tic e o f In te n tio n D a y
T h e C le a r in g C o r p e r a t io n m a t c h e s t h e o ld e s t lo n g t o t h e d e liv e r in g
s h o r t t h e n n o t ifie s b o t h p a r t ie s
T h e s h o r t in v o ic e s t h e lo n g .

D a y 3 D e liv e r y D a y
T h e s h o r t d e liv e r s t h e fin a n c ia l in s t r u m e n t t o t h e lo n g
T h e lo n g m a k e s p a y m e n t t o t h e s h o r t
T it le p a s s e s * T h e lo n g a s s u m e s a ll o w n e r s h ip r ig h t s a n d r e s p o n s ib lit ie s

B e fo r e D e liv e r y A fte r D e liv e r y

T h e s h o r t r e q u ir e s t h e fin a n c ia l T h e lo n g c a n :
In s tu r m e n t fo r * h o l d t h e f i n a n c i a l i n s t r u m e n t a n d r e t a i n o w46
n e r s h ip
d e liv e r y * r e d e liv e r in s t r u m e n t s
 Some Terminology
Open interest: the total number of
contracts outstanding = the number
of long positions or the number of
short positions

Volume of trading: the number of

trades in a specific contract in a day.

47
 FCM Phone Desk
Pit

Pulpit
(Rostrum)

Messengers

TRADING ON THE FLOOR

48
1 2

3 4

Day Trading: Open Outcry

and Hand Signals.
After Hours: Automated systems
49
 Trading Forwards

Vs

Trading futures.

Forwards: make a contract,

Then: wait
Then: delivery and payment

50
To understand the futures markets
observe the following
futures markets statistic:

97-98% of all the futures for all

delivery months and for all
underlying assets
do not get to delivery!!

Put differently:

Only 2-3% do reach delivery. 51

A futures markets statistic:
97-98% of all the futures for all
delivery months and for all
underlying assets
do not get to delivery!!

What is the implication of this

statistics?

52
 CONCLUSIONS:

Most traders close their positions

before they get to delivery.

Most traders do not open futures

positions for business.

Most futures are traded for financial

purpose
53
 Example 4: JUNE WTI FUTURE - 1,000 bbls PER CONTRACT

DATE PARTY NUM PRICE PARTY NUM PRICE VOL OPEN INT

Th.5.16 A:LONG 10 $90 CH B:SHORT 10 $90 10 10

5.16 C:LONG 25 $91 CH D:SHORT 25 $91 25 35

5.16 SETTLE $91 $91 35

Fr.5.17 E:LONG 10 $92 CH A:SHORT 10 $92 10 35

5.17 SETTLE $92 $92 10

Mo.5.20 D:LONG 25 $92.5 CH F:SHORT 25 $92.5 25 35

5.20 B:LONG 10 $91.5 CH C:SHORT 10 $91.5 10 25

5.20 SETTLE $91.5 $91.5 35

Tu.5.21 F:LONG 10 $91 CH E:SHORT 10 $91 10 15

5.21 SETTLE $90.5 $91 10

We.5.22 F:LONG 10 $90 CH C:SHORT 10 $90 10 5

5.22 SETTLE $90 $90 10

54
CLEARINGHOUSE ACCOUNTING

A: LONG 10; SHORT 10 : OUT

B: SHORT 10; LONG 10 : OUT

C: LONG 25; SHORT 10; SHORT 10

C remains LONG 5.

D: SHORT 25; LONG 25 : OUT

E: LONG 10; SHORT 10 : OUT

F: SHORT 25; LONG 10 : LONG 10

F remains SHORT
5. 55
5.23 F DECIDES TO DELIVER 5
CONTRACTS
C WILL ACCEPTS DELIVERY OF 5
CONTRACTS

5 contracts = 5,000 barrels

56
 CLEARINGHOUSE PROFIT/LOSS = ZERO*
LONG PRICE SHORT PRICE TOTAL PROFIT

A 10 $90 10 $92 $20,000

B 10 $91.5 10 $90 -$15,000
C 10 $91 10 $91.5 $5,000
10 $90 -$10,000
D 25 $92.5 25 $91 -$37,500
E 10 $92 10 $91 -$10,000
F 10 $91 25 $92.5 $15,000
10 $90 $25,000
TOTAL -$7,500

C TAKES DELIVERY 5 PAYS $91 : -$455,000

F DELIVERS 5 RECEIVES $92.5 : $462,500
$7,500
TOTAL 0

* This calculation accounts for buying and selling only. It does not account
for cash movements resulting from the daily marking-to-market process.
57
1. THE ACTUAL PROFITS AND LOSSES OF ALL MARKET
PARTICIPANTS
ARE ACCUMULATED
IN THEIR RESPECTIVE
MARGIN ACCOUNTS.
2. PAYMENT UPON DELIVERY IS DONE BASED
ON THE LAST SETTLEMENT PRICE
( In our example: $90/barrel the 5.22 settle.)

3. The exhibits in the following slides illustrate the activity in the

margin accounts of each of the traders focusing only on cash
flow resulting from the daily marking-to-market process.
Thus, possible margin calls are ignored.

58
PARTY A:

DATE ACTION PRICE SETTLE CASH FLOW POSITION

5.16 LONG 10 $90 Initial margin LONG 10

$91 +$10,000 LONG 10
5.17 SHORT 10 $92 +$10,000 0
TOTAL $20,000
As profit is = $20,000

PARTY B:

DATE ACTION PRICE SETTLE CASH FLOW POSITION

5.16 SHORT 10 $90 Initial margin SHORT 10

$91 -$10,000 SHORT 10
5.17 $92 -$10,000 SHORT 10
5.20 LONG 10 $91.5 +$5,000 0
TOTAL -$15,000

Bs loss is = $15,000

59
PARTY C:
DATE ACTION PRICE SETTLE CASH FLOW POSITION

5.16 LONG 25 $91 $91 Initial margin LONG 25

5.17 $92 +$25,000
5.20 SHORT 10 $91.5 - $5,000
$91.5 -$7,500 LONG 15
5.21 $90.5 -$15,000 LONG 15
5.22 SHORT 10 $90 -$5,000
$90 -$2,500 LONG 5
Cs total loss up to and including 5.22 is $10,000.

5.23 TAKE DELIVERY OF 5,000 BARRELS

for $90/bbl -$450,000 0

Note that the 5 contracts that were delivered has accumulated the following amount over the period:

5.17 (5,000)($1) = $5,000

5.20 (5,000)(-$.5) = -$2,500
5.21 (5,000)(-$1) = -$5,000
5.22 (5,000)(-$.5) = -$2,500
5.23 (5,000)(-$90) = -$450,000 Payment upon delivery
TOTAL.-$455,000
The five contracts have accumulated total payment of $455,000.

Observe: $455,000/5,000 = $91/bbl AS PER THE INITIAL COMMITMENT. 60

PARTY D:

DATE ACTION PRICE SETTLE CASH FLOW POSITION

5.16 SHORT 25 $91 Initial margin SHORT 25

$91 0 SHORT 25
5.17
$92 -$25,000 SHORT 25
5.20 LONG 25 $92.5 -$12,500 0
TOTAL -$37,500

Ds total loss is = $37,500

PARTY E:

DATE ACTION PRICE SETTLE CASH FLOW POSITION

5.17 LONG 10 $92 Initial margin LONG 10

$92 0 LONG 10
5.20 $91.5 -$5,000 LONG 10
5.21 SHORT 10 $91 -$5,000 0
TOTAL -$10,000

Es total loss is = $10,000

61
PARTY F:
DATE ACTION PRICE SETTLE CASH FLOW POSITION

5.20 SHORT 25 $92.5 Initial margin SHORT 25

$91.5 +$25,000
5.21 LONG 10 $91 +$5,000
$90.5 +$15,000 SHORT 15
5.22 LONG 10 $90 +$5,000
$90 +$2,500 SHORT 5
Fs total profit up to and including 5.22 is $52,500.

5.23 DELIVER 5,000 BARRELS

for $90/bbl +$950,000 0

Note that the 5 contracts that were delivered has accumulated the following amount over the period:

5.20 (5,000)($1) = $5,000

5.21 (5,000)($1) = $5,000
5.22 (5,000)($.5) = $2,500
5.23 (5,000)($90) = $450,000 Payment upon delivery

TOTAL..$462,500

The five contracts that party F delivers accumulated a total of $462,500.

Observe: $462,500/5,000 = $92.5/bbl AS PER INITIAL COMMITMENT. 62

 HOW ARE FUTURES
CONTRACTS
CREATED ?

FUTURES CONTRACTS ARE

SUGGESTED BY THE FUTURES EXCHANGES.
THE PROPOPSALS ARE SENT FOR APPROVAL
TO THE REGULATORY AUTHORITY:
In the US:

THE FUTURES
COMMODITY TRADING COMMISSION.
(FCTC) 63
 THE MARKET PARTICIPANTS:
TRADERS OF FUTURES MAY BE
CLASSIFIED BY THEIR GOALS:
SPECULATORS: OPEN A RISKY FUTURES POSITION FOR
EXPECTED PROFITS.

ARBITRAGERS: OPEN SIMULTANEOUS FUTURES AND

CASH POSITIONS IN ORDER TO MAKE
ARBITRAGE PROFITS.

HEDGERS: OPEN A FUTURES POSITION IN ORDER TO

ELIMINATE SPOT PRICE RISK.

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 SPECULATORS:
TAKE RISK FOR EXPECTED PROFIT.

ON THE MARKET FLOOR, WE FIND EXCHANGE MEMBERS WHO TRADE

FOR THEIR ON ACCOUNTS. THESE ARE SPECULATORS.

SCALPERS: LARGE POSITIONS SMALL PRICE MOVEMENTS

NEVER STAY OPEN OVERNIGHT

DAY TRADERS: OPEN A POSITION IN THE MORNING. CLOSE AT THE

CLOSE OF THE SAME DAY.

POSITION TRADERS: HOLD OPEN POSITIONS FOR LONGER PERIODS .

OUTRIGHT SPECULATION: GO LONG or GO SHORT

A SPREAD: LONG CONTRACT 1

and simultaneously
SHORT CONTRACT 2 65
PROFIT IN SPREADS: MISALIGNMENT OF
TWO DIFFERENT FUTURES PRICES

CROSS COMMODITY SPREAD:

SHORT JUNE CRUDE OIL CONTRACT
LONG JUNE HEATING OIL CONTRACT

CROSS EXCHANGE SPREAD

LONG WHEAT CBT
SHORT WHEAT KCB

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 CALENDAR SPREAD
Definition: A long position with a
simultaneous short position on the
same underlying asset for two
different delivery months, T1 y T2.
The spread is the price difference

Spread0 = F0,T1 - F0,T2

Long T2 and Short T1

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Example:

LONG POSITION CONTRACT for JUNE

SHORT POSTION CONTRACT for SEPTEMBER.

Spread0 = F0,SEP - F0,JUN

How does a spread function?

It depends on the speculators expectation.
Will the spread will narrow in the future?
or
Will the spread widen in the future?

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 How to open the spread?
Rule 1: If the spread is expected to narrow:
SELL THE SPREAD! How?
Buy the low priced contract and sell
the high priced contract
Rule 2: If spread is expected to widen:
BUY THE SPREAD! How?
Buy the high priced contract and sell
the low priced contract.

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CALENDAR SPREAD 1:
3 MAR F(JULY) F(DECEMBER)
SPREAD
USD0.90/CD USD1.02/CD
USD0.12/CD
The speculator: The spread will narrow. Use Rule 1:
Sell the spread, that is, buy n futures for JUL
sell n futures for DEC
Assume that two weeks later the prices are:
17 MAR F(JULY) F(DECEMBER) SPREAD
USD0.94/CD USD0.99/CD USD0.05/CD
Close the spread: that is, sell n futures for JUL
buy n futures for DEC
GAIN: [USD0.12/CD - USD0.05/CD](n)(100,000CD)
For example: if n = 25 CME contracts the gain is: 70

[USD0.07/CD](25)(CD100,000) = USD175,000.
CALENDAR SPREAD 2:
3 MAR F(JULY) F(DECEMBER)
SPREAD
USD0.90/CD USD1.02/CD
USD0.12/CD
The speculator: The spread will widen. apply rule 2.
Buy the spread , that is, sell n futures for JUL
buy n futures for DEC.
Some time later:
24 MAR F(JULY) F(DECEMBER) SPREAD
USD0.92/CD USD1.08/CD USD0.16/CD
Close the spread, that is, buy n futures for JUL
sell n futures for DEC
The Gain: [-USD0.12/CD + USD0.16/CD](n)(100,000CD)
For example: if n = 25 CME contracts the gain is: 71

[USD0.04/CD](25)(CD100,000) = USD100,000.