D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Chapter 8: The Structure of Forward and Futures Markets

It is like watching your favorite soap opera. You know all It is like watching your favorite soap opera. You know all the characters. You know the plot. But you never really the characters. You know the plot. But you never really know how the day is going to end.know how the day is going to end.

Turk OzdekTurk OzdekFuturesFutures, July 2001, p. 86, July 2001, p. 86

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Important Concepts in Chapter 8 Definitions and examples of forward and futures contractsDefinitions and examples of forward and futures contracts Institutional characteristics of forward and futures marketsInstitutional characteristics of forward and futures markets Futures contracts available for tradingFutures contracts available for trading Placing an order, margins, daily settlementPlacing an order, margins, daily settlement The role of the clearinghouseThe role of the clearinghouse Accessing futures price quotationsAccessing futures price quotations Magnitude and effects of transaction costsMagnitude and effects of transaction costs

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Development of Forward and Futures Markets

Chicago Futures MarketsChicago Futures Markets The Development of Financial FuturesThe Development of Financial Futures The Development of Options on Futures MarketsThe Development of Options on Futures Markets The Parallel Development of Over-the-Counter MarketsThe Parallel Development of Over-the-Counter Markets

interbank marketinterbank market growth of forward marketsgrowth of forward markets

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Over-the-Counter Forward Market

customizedcustomized privateprivate essentially unregulatedessentially unregulated credit riskcredit risk market size: $18 trillion face value, $400 billion market market size: $18 trillion face value, $400 billion market

value at year-end 2001value at year-end 2001

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Organized Futures Trading Contract DevelopmentContract Development Contract Terms and ConditionsContract Terms and Conditions

contract sizecontract size quotation unitquotation unit minimum price fluctuationminimum price fluctuation contract gradecontract grade trading hourstrading hours

Delivery TermsDelivery Terms delivery date and timedelivery date and time delivery or cash settlementdelivery or cash settlement

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Organized Futures Trading (continued)

Daily Price Limits and Trading HaltsDaily Price Limits and Trading Halts limit moveslimit moves circuit breakerscircuit breakers

Other Exchange ResponsibilitiesOther Exchange Responsibilities minimum financial responsibility requirementsminimum financial responsibility requirements position limitsposition limits rules governing the trading floorrules governing the trading floor

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Futures Exchanges

See See Table 8.1, p. 279Table 8.1, p. 279 for list of exchanges. for list of exchanges. Global and after-hours tradingGlobal and after-hours trading Estimated world-wide volume in 2001 was 1.8 billion Estimated world-wide volume in 2001 was 1.8 billion

contracts.contracts.

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Futures Traders

General Classes of Futures TradersGeneral Classes of Futures Traders futures commission merchantsfutures commission merchants localslocals dual tradingdual trading

Classification by Trading StrategyClassification by Trading Strategy hedger/speculatorhedger/speculator spreaderspreader arbitrageurarbitrageur

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Futures Traders (continued) Classification by Trading StyleClassification by Trading Style

scalpersscalpers day tradersday traders position tradersposition traders

Off-Floor Futures TradersOff-Floor Futures Traders individualsindividuals institutionsinstitutions Others: Introducing Broker (IB), Commodity Trading Others: Introducing Broker (IB), Commodity Trading

Advisor (CTA), Commodity Pool Operator (CPO), Advisor (CTA), Commodity Pool Operator (CPO), Associated Person (AP)Associated Person (AP)

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Futures Traders (continued)

The Cost and Profitability of Exchange MembershipThe Cost and Profitability of Exchange Membership seatsseats See See Figure 8.1, p. 283Figure 8.1, p. 283 for history of CBOT, CME, and for history of CBOT, CME, and

NYMEX seat prices.NYMEX seat prices. leasing a seat at around 1.0 - 1.5 %/mo. of seat priceleasing a seat at around 1.0 - 1.5 %/mo. of seat price profitability of membershipprofitability of membership

Forward Market TradersForward Market Traders over-the-counterover-the-counter primarily institutionsprimarily institutions

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Mechanics of Futures Trading

Placing an OrderPlacing an Order pitpit open outcryopen outcry electronic systemselectronic systems

The Role of the ClearinghouseThe Role of the Clearinghouse See See Figure 8.2, p. 285Figure 8.2, p. 285.. margin depositsmargin deposits

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Mechanics of Futures Trading (continued)

Daily SettlementDaily Settlement initial margininitial margin maintenance marginmaintenance margin concept of “margin” vs. performance bondconcept of “margin” vs. performance bond settlement pricesettlement price variation marginvariation margin See See Table 8.2, p. 287Table 8.2, p. 287 for example. for example. open interestopen interest

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Mechanics of Futures Trading (continued)

Delivery and Cash SettlementDelivery and Cash Settlement three-day delivery processthree-day delivery process alternative deliverable gradesalternative deliverable grades offsettingoffsetting exchange for physicalsexchange for physicals forward market proceduresforward market procedures

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Futures Price Quotations

Newspapers and web sitesNewspapers and web sites

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Types of Futures Contracts Agricultural CommoditiesAgricultural Commodities Natural ResourcesNatural Resources Miscellaneous CommoditiesMiscellaneous Commodities Foreign CurrenciesForeign Currencies Treasury Bills and EurodollarsTreasury Bills and Eurodollars Treasury Notes and BondsTreasury Notes and Bonds EquitiesEquities Managed FundsManaged Funds Hedge FundsHedge Funds Options on FuturesOptions on Futures

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Transaction Costs in Forward and Futures Trading

CommissionsCommissions Bid-Ask SpreadBid-Ask Spread Delivery CostsDelivery Costs

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Regulation of Futures Markets

Regulation is nearly always at the federal level; e.g.,Regulation is nearly always at the federal level; e.g., Commodity Futures Trading Commission (U.S.)Commodity Futures Trading Commission (U.S.) Financial Services Authority (U.K.)Financial Services Authority (U.K.) Financial Services Agency (Japan)Financial Services Agency (Japan)

Objective of most federal regulationObjective of most federal regulation ensuring public information availableensuring public information available authorization and licensing of contracts and authorization and licensing of contracts and

exchangesexchanges contract approvalcontract approval market surveillancemarket surveillance

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Regulation of Futures Markets (continued) Arbitration of disputes is sometimes done through the Arbitration of disputes is sometimes done through the

federal government and the courts but often through self-federal government and the courts but often through self-regulatory organizations such as the National Futures regulatory organizations such as the National Futures Association in the U. S.Association in the U. S.

Note: Forward markets are regulated only indirectly and, Note: Forward markets are regulated only indirectly and, thus, are largely unregulated.thus, are largely unregulated.

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Summary

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Appendix 8: Taxation of Futures Contracts

Treated as 60 % capital gains and 40 % ordinary income.Treated as 60 % capital gains and 40 % ordinary income. Capital gains subject to 28 % maximum.Capital gains subject to 28 % maximum. Must be marked to market at year end.Must be marked to market at year end. New single stock futures are taxed the same as individual New single stock futures are taxed the same as individual

stocks.stocks. Hedge transactions covered in Chapter 10.Hedge transactions covered in Chapter 10.

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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