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STOCK FUTURESSUBJECT - DERIVATIVES MARKETSGUIDE SANJAY RODE
08/09/2011
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Group
1.AAKASH HINDOCHA015
2.ROMIT PARIKH..033
3.RUSHABH SETH.042
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INDEX
NOS TOPIC
1 INTRODUCTION
2 BRIEF HISTORY OF SINGLE STOCK FUTURES
3 DIFFERENT FROM STOCK OPTIONS
4 OPPORTUNITIES OFFERED BY STOCK FUTURES
5 STOCK FUTURES TRADING
6 MARKET OUTCOME
7 PARTIES IN SINGLE STOCK FUTURES TRANSACTIONS
8 BENEFIT OF TRADING SINGLE STOCK FUTURES
9 WHERE ARE SINGLE STOCK FUTURES TRADED ?
SINGLE STOCK FUTURES MARKET
10 RISK OF SINGLE STOCK FUTURES11 EFFECT OF INDEX FUTURES ON STOCK MARKET
12 OTHER RECOMMENDATION
13 STANDARIZATION
14 MARGIN
15 FUTURE CONTRACTS
16 WHO TRADES FUTURES
17 CONCLUSION
18 BIBLIOGRAPHY
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INTRODUCTION
Stock Futures are financial contracts where the underlying asset is an
individual stock. Stock Future contract is an agreement to buy or sell a
specified quantity of underlying equity share for a future date at a price
agreed upon between the buyer and seller. The contracts have
standardized specifications like market lot, expiry day, and unit of price
quotation, tick size and method of settlement.
Agreements to buy or sell a standardized value of a stock index, on a future
date at a specified price, such as trading New York Stock Exchange
composite index on the New York Futures Exchange (NYFE). As an
investment instrument it combines features of securities trading based on
stock indices with the features of commodity futures trading. It allows
investors to speculate on the entire stock market's performance, short sell
(see short sale) an index with a futures contract, or to hedge a long position
against a decline in value.
A futures contract is a type of derivative instrument, or financial contract, in
which two parties agree to transact a set of financial instruments or
physical commodities for future delivery at a particular price. If you buy a
futures contract, you are basically agreeing to buy something that a seller
http://www.businessdictionary.com/definition/agreement.htmlhttp://www.businessdictionary.com/definition/buy.htmlhttp://www.businessdictionary.com/definition/sell.htmlhttp://www.businessdictionary.com/definition/value.htmlhttp://www.businessdictionary.com/definition/stock-index.htmlhttp://www.investorwords.com/9809/future.htmlhttp://www.businessdictionary.com/definition/labor-rate-price-variance.htmlhttp://www.investorwords.com/5030/trading.htmlhttp://www.businessdictionary.com/definition/New-York-Stock-Exchange-NYSE-composite-index.htmlhttp://www.businessdictionary.com/definition/New-York-Stock-Exchange-NYSE-composite-index.htmlhttp://www.investorwords.com/3276/New_York_Futures_Exchange.htmlhttp://www.investorwords.com/3369/NYFE.htmlhttp://www.businessdictionary.com/definition/investment-instrument.htmlhttp://www.investorwords.com/9217/combine.htmlhttp://www.businessdictionary.com/definition/feature.htmlhttp://www.businessdictionary.com/definition/securities.htmlhttp://www.businessdictionary.com/definition/stock.htmlhttp://www.businessdictionary.com/definition/indices.htmlhttp://www.businessdictionary.com/definition/commodity-futures.htmlhttp://www.investorwords.com/8807/allow.htmlhttp://www.businessdictionary.com/definition/investor.htmlhttp://www.businessdictionary.com/definition/speculate.htmlhttp://www.businessdictionary.com/definition/performance.htmlhttp://www.investorwords.com/5961/short_sell.htmlhttp://www.businessdictionary.com/definition/short-sale.htmlhttp://www.businessdictionary.com/definition/index.htmlhttp://www.businessdictionary.com/definition/futures-contract.htmlhttp://www.businessdictionary.com/definition/hedge.htmlhttp://www.businessdictionary.com/definition/long-position.htmlhttp://www.investorwords.com/8787/against.htmlhttp://www.investorwords.com/1335/decline.htmlhttp://www.wikinvest.com/wiki/Derivativeshttp://www.wikinvest.com/wiki/Derivativeshttp://www.investorwords.com/1335/decline.htmlhttp://www.investorwords.com/8787/against.htmlhttp://www.businessdictionary.com/definition/long-position.htmlhttp://www.businessdictionary.com/definition/hedge.htmlhttp://www.businessdictionary.com/definition/futures-contract.htmlhttp://www.businessdictionary.com/definition/index.htmlhttp://www.businessdictionary.com/definition/short-sale.htmlhttp://www.investorwords.com/5961/short_sell.htmlhttp://www.businessdictionary.com/definition/performance.htmlhttp://www.businessdictionary.com/definition/speculate.htmlhttp://www.businessdictionary.com/definition/investor.htmlhttp://www.investorwords.com/8807/allow.htmlhttp://www.businessdictionary.com/definition/commodity-futures.htmlhttp://www.businessdictionary.com/definition/indices.htmlhttp://www.businessdictionary.com/definition/stock.htmlhttp://www.businessdictionary.com/definition/securities.htmlhttp://www.businessdictionary.com/definition/feature.htmlhttp://www.investorwords.com/9217/combine.htmlhttp://www.businessdictionary.com/definition/investment-instrument.htmlhttp://www.investorwords.com/3369/NYFE.htmlhttp://www.investorwords.com/3276/New_York_Futures_Exchange.htmlhttp://www.businessdictionary.com/definition/New-York-Stock-Exchange-NYSE-composite-index.htmlhttp://www.businessdictionary.com/definition/New-York-Stock-Exchange-NYSE-composite-index.htmlhttp://www.investorwords.com/5030/trading.htmlhttp://www.businessdictionary.com/definition/labor-rate-price-variance.htmlhttp://www.investorwords.com/9809/future.htmlhttp://www.businessdictionary.com/definition/stock-index.htmlhttp://www.businessdictionary.com/definition/value.htmlhttp://www.businessdictionary.com/definition/sell.htmlhttp://www.businessdictionary.com/definition/buy.htmlhttp://www.businessdictionary.com/definition/agreement.html -
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has not yet produced for a set price. But participating in the futures market
does not necessarily mean that you will be responsible for receiving or
delivering large inventories of physical commodities - remember, buyers
and sellers in the futures market primarily enter into futures contracts to
hedge risk or speculate rather than to exchange physical goods (which is
the primary activity of the cash/spot market). That is why futures are used
as financial instruments by not only producers and consumers but also
speculators.
The first futures exchange market was the Dojima Rice Exchange in Japan
in the 1730s, to meet the needs of samurai whobeing paid in rice, and
after a series of bad harvestsneeded a stable conversion to coin.
A closely related contract is a forward contract. A forward is like a future 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. Nor is
the contract standardized, as on the exchange.
Unlike an option, both parties of a futures contract must fulfill the contract
on the delivery date. The seller delivers the underlying asset to the buyer,
or, if it is a cash-settled futures contract, then cash is transferred from the
futures trader who sustained a loss to the one who made a profit. To exit
the commitment prior to the settlement date, the holder of a futures position
can close out its contract obligations by taking the opposite position on
another futures contract on the same asset and settlement date. The
difference in futures prices is then a profit or loss.
http://en.wikipedia.org/wiki/D%C5%8Djima_Rice_Exchangehttp://en.wikipedia.org/wiki/Samuraihttp://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Option_%28finance%29http://en.wikipedia.org/wiki/Position_%28finance%29http://en.wikipedia.org/wiki/Position_%28finance%29http://en.wikipedia.org/wiki/Option_%28finance%29http://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Samuraihttp://en.wikipedia.org/wiki/D%C5%8Djima_Rice_Exchange -
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BRIEF HISTORY OF SINGLE STOCK FUTURES
Single Stock Futures started trading in the US market on November 8,
2002.
Prior to 2002, trading of futures contracts on securities were disallowed as
a proper regulatory authority cannot be determined.
This changed in 2000 with the passing of the Commodity Futures
Modernization Act of 2000, where the Commodity Futures Trading
Commission and the U.S. Securities and Exchange Commission agreed to
oversee and regulate the trading of single stock futures jointly.
It was until 2002 when the first two single stock futures exchange started
trading, one of which has closed down, with OneChicago Exchange still
active today.
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DIFFERENT FROM STOCK OPTIONS
In stock options, the option buyer has the right and not the obligation, to
buy or sell the underlying share. In case of stock futures, both the buyer
and seller are obliged to buy/sell the underlying share.
Risk-return profile is symmetric in case of single stock futures whereas in
case of stock options payoff is asymmetric.
Also, the price of stock futures is affected mainly by the prices of the
underlying stock whereas in case of stock options, volatility of the
underlying stock affects the price along with the prices of the underlying
stock.
Futures and stock options are the two most widely publicized leveraged
derivative instruments in the world today. In fact, futures and options are
the two most widely used hedging instrument in the world as well.
This have inevitably led many investors into thinking that futures and stock
options are the same thing. In fact, there have been laymen investors
referring to both instruments collectively as "Options Futures". Nothing can
be further from the truth.
Futures and options are two different things and a future trading really has
nothing to do with options trading. Futures and options serve different
needs in the capital market and will forever be important elements on their
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own in every well diversified portfolio. Even though futures and options are
two different things, even since the invention of options on futures, that is,
options with futures as their underlying asset, this distinction has been
greatly blurred and made it all the more confusing for beginners to futures
and options trading.
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OPPORTUNITIES OFFERED BY STOCK FUTURES
(1) Stock futures are used for hedging the risk arising out of investment
in cash segment of the stock exchange.
(II) Speculation gains (by taking the risk of speculative loss) can be
made.
(III) Arbitrage gain can be made by combing the futures market
transactions with cash market transactions or options.
Stock futures offer a variety of usage to the investors. Some of the key
usages are mentioned below:
Investors can take long term view on the underlying stock using stock
futures.
Stock futures offer high leverage. This means that one can take large
position with less capital. For example, paying 20% initial margin one can
take position for 100 i.e. 5 times the cash outflow.
Futures may look overpriced or under priced compared to the spot and can
offer opportunities to arbitrage or earn risk-less profit. Single stock futures
offer arbitrage opportunity between stock futures and the underlying cash
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market. It also provides arbitrage opportunity between synthetic futures
(created through options) and single stock futures.
When used efficiently, single-stock futures can be an effective risk
management tool. For instance, an investor with position in cash segment
can minimize either market risk or price risk of the underlying stock by
taking reverse position in an appropriate futures contract.
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STOCK FUTURES TRADING
Yes, a single stock future trading is a leveraged speculation on the price of
the underlying stock.
The short benefits when the price of the underlying stock falls because the
single stock futures contract allows the short to sell the underlying stock at
a higher price. The long benefits when the price of the underlying stock
rises because the single stock futures contract allows the long to buy the
underlying stock at a lower price. Clearly, one would take the short side
when speculating on a drop in the price of the underlying stock while one
would take the long side when speculating on a rise in the price of the
underlying stock.
No matter which side of the single stock futures trade you take, an initial
margin is payable to the futures exchange for entering into the futurestrading contract. Yes, this is unlike options trading where the short actually
receive payment for the options contract that is sold. In futures trading, both
the short and the long pays an initial margin for participating in the trade.
Even though the transaction for the underlying stock only take place upon
maturity of the single stock futures contract, profits and losses incurred by
the contracts are actually settled daily. This is a risk control measure set in
place by the Clearing Houses in order to ensure that participants in the
futures contract are able to fulfil their obligations upon maturity of the
futures contract. This is where the risk of trading single stock futures lie. If
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the stock should move against your favor (upwards when you are short or
downwards when you are long), losses for the day is deducted from the
initial margin that you deposited when putting on the position. When that
initial margin goes down to a certain level, you receive a margin call to top
up the deposit to the initial margin level otherwise your position is closed in
what is known as a "forced liquidation" where the broker closes your
position. As such, short term volatility can be extremely dangerous if a
single stock futures position is not backed up by a significant fund ready for
margin calls.
Conversely, if the stock moves in your favor (upwards when you are long or
downwards when you are short), profits for the day are credited to your
account, increasing the deposit that you made as initial margin. Your initial
margin will continue building up on a daily basis as long as the stock
continues to move in your favor, creating a base of profits acting as buffer
should the stock move against you temporarily. This is why good entry
points in single stock futures trading is so important. It can be critical for the
stock to move in your favor during the first few days of putting on the
position so that a good profit base is formed to absorb losses when the
stock moves temporarily against your favor.
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MARKET OUTCOME
1. In India derivatives are traded only on two exchanges.
2. The details of trades on these exchanged during 2002-03 are presented in the
table below.
3. The total exchange traded derivatives witnessed a volume of Rs. 4423333
million during the current year as against Rs. 1038480 million during the
preceding year.
4. While NSE accounted for about 99.4%of total turnover, BSE accounted for
less than 1%. It is believed that India is the second largest market in the world
for stock future
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PARTIES IN SINGLE STOCK FUTURES TRANSACTIONS
Even though a futures transaction is theoretically an agreement between a
buyer and a seller, there are really 3 parties involved in every Single Stock
Futures transaction; the long, the short and the clearing house.
Single Stock Futures are guaranteed contracts. This means that both buyer
and seller are guaranteed their "winnings" and there is no risk of default.This guarantee against default is made possible by the clearing house. The
clearing house is the organization that all single stock futures traders are
really trading with. The clearing house puts itself in the middle of each
single stock futures transaction and obligates itself to the fulfillment of all
futures contracts. This provides the performance guarantee that ensures
liquidity in the futures market.
When you go long or short on a single stock futures contract, the clearing
house creates one new futures contract just for you. There really isn't a
short side selling that contract to you. You are really trading with the
clearing house. The clearing house then deposits your "winnings" or
deducts your "losses" on a daily basis through the mark to market process.
When you decide to close the position, the clearinghouse offsets your
position with an equal and opposite transaction from another party and
when you hold to maturity, the clearing house randomly selects another
single stock futures trader with an opposite transaction to deliver the stocks
or buy your stocks.
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BENEFITS OF TRADING SINGLE STOCK FUTURES
The main benefit of trading Single Stock Futures is definitely leverage. The
ability to do more with the same amount of money. Single stock futures
allow you to control the same amount of stock with only 20% of the price as
we have discussed above. Apart from being a leverage instrument, single
stock futures can also be hedging instruments for stocks or options
positions. By taking a short side on a portfolio of stocks, you effectively
nullify any directional risk and this can be useful when stocks are expectedto take a short term hit. Single stock futures can also be shorted to hedge
against a call options position or longed to hedge against a put options
position.
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Another benefit of buying Single Stock Futures rather than buying the
underlying stock itself is that buying Single Stock Futures allows you to
keep the remainder of the cash, which would otherwise have been invested
if you had bought the underlying stock itself, in the bonds markets to earn a
risk free rate of return! When you buy stock, your cash can no longer
generate a risk free rate of return and that loss on interest is your
opportunity cost right from the start. However, if you had bought Single
Stock Futures instead, you would have been able to invest the remaining
80% (assuming a 20% initial margin requirement) at the risk free rate of
return and thus reduce your opportunity cost. However, this benefit is a
concern mainly for investors investing very big funds. For the common
retail futures traders, this is not too much of a concern.
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WHERE ARE SINGLE STOCK FUTURES TRADED?
- SINGLE STOCK FUTURES MARKETS
Single Stock Futures are traded in many countries such as USA, Australia,
Canada, Finland, Hong Kong, Spain, Sweden and UK.
In the USA, Single Stock Futures are traded in the USA through an
electronic marketplace known as , One Chicago LLC. Several other
exchanges such as AMEX are also looking to participate in electronic
trading of Single Stock Futures (SSF) trading.
In order to trade Single Stock Futures, all you have to do is open an online
trading account with any of the Online Futures Trading Brokers and they
will fill your orders in the respective marketplace for you. It's that simple.
Most of these brokers would also support options trading because options
is an important hedge for futures.
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RISKS OF SINGLE STOCK FUTURES
The single most significant risk of trading single stock futures is that fact
that you can lose more than the money you initially started the trade with.
If you are long a single stock futures position and the stock drops
drastically in a single day, you could lose enough in one day to warrant a
margin call and if you don't have enough money to fulfill the margin call,
your position would not only be forcefully closed but you would also end up
owing money to your broker.
This is how many multi-billion dollar companies collasped overnight trading
futures. As such, careful risk management in terms of leverage and cash
reserve needs to be planned out when trading single stock futures.
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EFFECT OF INTRODUCTION OF INDEX FUTURES ON STOCK MARKET
VOLATILITY: THE INDIAN EVIDENCE
The Indian capital market has witnessed a major transformation and structural
change during the past one decade or so as a result of on going financial sector
reforms initiated by the Government of India since 1991 in the wake of policies of
liberalization and globalization. The major objectives of these reforms have been to
improve market efficiency, enhancing transparency, checking unfair trade practices,
and bringing the Indian capital market up to international standards. As a result of the
reforms several changes have also taken place in the operations of the secondary
markets such as automated on-line trading in exchanges enabling trading terminals of
the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) to be
available across the country and making geographical location of an exchange
irrelevant; reduction in the settlement period, opening of the stock markets to foreign
portfolio investors etc. In addition to these developments, India is perhaps one of the
real emerging markets in South Asian region that has introduced derivative products
on two of its principal existing exchanges viz; BSE and NSE in June 2000 to provide
tools for risk management to investors. There had, however, been a considerable
debate on the question of whether derivatives should be introduced in India or not.
The L.C. Gupta Committee on Derivatives, which examined the whole issue in
details, had recommended in December 1997 the introduction of stock index futures
in the first place (1). The preparation of regulatory framework for the operations of the
index futures contracts took another two and a half year more as it required not only
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an amendment in the Securities Contracts(Regulation) Act, 1956 but also the
specification of the regulations for such contracts. Finally, the Indian capital market
saw the launching of index futures on June 9, 2000 on BSE and on June 12, 2000 on
the NSE. A year later options on index were also introduced for trading on these
exchanges. Later, stock options on individual stocks were launched in July 2001.
The latest product to enter in to the derivative segment on these exchanges is
contracts on stock futures in November 2001. Thus, with the launch of stock futures,
the basic range of equity derivative products in India seems to be complete.
Despite the existence of a well-developed stock market for over a hundred years,
trading on derivative contracts in India (index futures) started only in June 2000. It is
but natural that the market players took time to understand the intricacies involved in
the operations of these new instruments. This is clearly reflected in the growth of
business in the index futures contracts during the period June 2000 to June 2002.
The growth can at the best be said to be modest not only in terms of the number of
contracts involved but also in terms of value of such contracts.
As far as developed capital markets are concerned, a number of in-depth studies
have been carried out to examine various issues relating to financial derivatives. In
recent years, some attempts have also been made to study various aspects of index
futures relating to emerging markets. Since the introduction of index futures in India is
are cent phenomenon, there has hardly been any attempt to examine the impact of
their introduction on the underlying stock market volatility.
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OTHER RECOMMENDATION
From the purely regulatory angle, a separate exchange for futures trading seems to
be a neater arrangement. However, considering the constraints in infrastructure
facilities , the existing stock exchanges having cash trading may also be permitted to
trade derivatives provided they meet the minimum eligibility conditions as indicated
below:
1. The trading should take place through an online screen based trading system
which also has a disaster recovery site. The per half hour capacity of the computers
and the network should be at least 4 to 5 times of the anticipated peak load in any half
hour or of the actual peak load seen in any half hour during the preceding six months.
This shall be reviewed from time to time on the basis of experience.
2. The clearing of the derivatives market should be done by an independent clearing
corporation, which satisfies the conditions listed.
3. The exchange must have an online surveillance capacity which moniters positions,
prices and volumes in real time so as to deter market manipulation. Price and position
limits should be used for improving market quality.
4. Information about trades, quantities and quotes should be disseminated by the
exchange in real time over at least two information vending networks which are
accessible to investors in the country.
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5. The exchange should have at least 50 members to start derivatives trading.
6. If derivatives trading is to take place at an existing cash market, it should be done in
a separate segment with a separate membership i.e., all members of the existing
cash market would not automatically become members of the derivatives market.
7. The derivatives market should have a separate governing council which shall not
have representation of trading/clearing members of the derivatives Exchange beyond
whatever percentage SEBI may prescribe after reviewing the working of the present
governance system of exchanges.
8. The Chairman of the Governing Council of the Derivative Division/Exchange shall
be a member of the Governing Council, if the chairman is a Broker/dealer, then, he
shall not carry on any broking or dealing business on any Exchange during his tenure
as Chairman.
9. The exchange should have arbitration and investor grievances redressal
mechanism operative from all the four areas/regions of the country.
10. The exchange should have an adequate inspection capability.
11. No trading/clearing member should be allowed simultaneously to be on the
governing council of both the derivatives market and the cash market.
12. If already existing, the exchange should have a satisfactory record of monitoring
its members, handling investor complaints and preventing irregularities in trading
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STANDARDIZATION
Futures contractsensure their liquidity by being highly standardized,
usually by specifying:
1. Theunderlyingasset or instrument. This could be anything from a
barrel of crude oil to a short term interest rate.
2. The type of settlement, either cash settlement or physical settlement.
3. The amountand units of the underlying asset per contract. This can
be the notional amount of bonds, a fixed number of barrels of oil,
units of foreign currency, the notional amount of the deposit over
which the short term interest rate is traded, etc.
4. The currency in which the futures contract is quoted.
5. The gradeof the deliverable. In the case of bonds, this specifies
which bonds can be delivered. In the case of physical commodities,
this specifies not only the quality of the underlying goods but also the
manner and location of delivery. For example, the NYMEX Light
Sweet Crude Oil contract specifies the acceptable sulphur content
and API specific gravity, as well as the pricing point -- the location
where delivery must be made.
6. The delivery month
7. The last trading date.
8. Other details such as the commodity tick, the minimum permissible
price fluctuation.
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MARGIN
To minimize credit risk to the exchange, traders must post a margin or a
performance bond, typically 5%-15% of the contract's value.
To minimize counterparty risk to traders, trades executed on regulated
futures exchanges are guaranteed by a 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 hedgers
who have physical ownership of the covered commodity 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
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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. Initial margin is set by the exchange.
If a position involves an exchange-traded product, the amount or
percentage of 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 or calls intra-day.
Calls for margin 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 clients account.
Some U.S. exchanges also use the term maintenance margin, which in
effect defines by how much the value of the initial margin can reducebefore a margin call is made. However, most non-US brokers only use the
term initial margin and variation margin.
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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 his 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
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 exchanges perceived risk as
reflected in required margin. ROM may be calculated (realized return) /
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(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.
FUTURES CONTRACTS
Contracts
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 article.
Foreign exchange market
Money market Bond market
Equity market
Soft Commodities market
http://en.wikipedia.org/wiki/Single-stock_futureshttp://en.wikipedia.org/wiki/Commodity_marketshttp://en.wikipedia.org/wiki/List_of_traded_commoditieshttp://en.wikipedia.org/wiki/List_of_traded_commoditieshttp://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/Foreign_exchange_markethttp://en.wikipedia.org/wiki/Money_markethttp://en.wikipedia.org/wiki/Bond_markethttp://en.wikipedia.org/wiki/Equity_derivative#Equity_futures.2C_options_and_swapshttp://en.wikipedia.org/wiki/Soft_Commodities_markethttp://en.wikipedia.org/wiki/Soft_Commodities_markethttp://en.wikipedia.org/wiki/Equity_derivative#Equity_futures.2C_options_and_swapshttp://en.wikipedia.org/wiki/Bond_markethttp://en.wikipedia.org/wiki/Money_markethttp://en.wikipedia.org/wiki/Foreign_exchange_markethttp://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/List_of_traded_commoditieshttp://en.wikipedia.org/wiki/List_of_traded_commoditieshttp://en.wikipedia.org/wiki/Commodity_marketshttp://en.wikipedia.org/wiki/Single-stock_futures -
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Trading on 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.
WHO TRADES FUTURES?
Futures traders are traditionally placed in one of two groups: hedgers, who
have an interest in the underlying asset (which could include an intangiblesuch as an index or interest rate) and are seeking to hedge outthe risk of
price changes; and speculators, who seek to make a profit by predicting
market moves and opening a derivative contract related to the asset "on
paper", while they have no practical use for or intent to actually take or
http://en.wikipedia.org/wiki/Soft_Commodities_markethttp://en.wikipedia.org/wiki/Commodityhttp://en.wikipedia.org/wiki/Hedge_%28finance%29http://en.wikipedia.org/wiki/Speculatorhttp://en.wikipedia.org/wiki/Derivative_%28finance%29http://en.wikipedia.org/wiki/Derivative_%28finance%29http://en.wikipedia.org/wiki/Speculatorhttp://en.wikipedia.org/wiki/Hedge_%28finance%29http://en.wikipedia.org/wiki/Commodity -
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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.
Speculators
Speculators typically fall into three categories: position traders, day traders,
and swing traders (swing trading), though many hybrid types and unique
styles exist. In general position traders hold positions for the long term
(months to years), day traders (or active traders) enter multiple trades
during the day and will have exited all positions by market close, and swingtraders aim to buy or sell at the bottom or top of price swings.[7]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.[8]
http://en.wikipedia.org/wiki/Consumerhttp://en.wikipedia.org/wiki/Commodity_markethttp://en.wikipedia.org/wiki/Farmerhttp://en.wikipedia.org/wiki/Interest_rate_swapshttp://en.wikipedia.org/wiki/Interest_rate_swapshttp://en.wikipedia.org/wiki/Equity_derivativehttp://en.wikipedia.org/wiki/Swap_%28finance%29http://en.wikipedia.org/wiki/Day_tradershttp://en.wikipedia.org/wiki/Swing_tradinghttp://en.wikipedia.org/wiki/Futures_contracts#cite_note-6http://en.wikipedia.org/wiki/Futures_contracts#cite_note-6http://en.wikipedia.org/wiki/Futures_contracts#cite_note-6http://en.wikipedia.org/wiki/Futures_contracts#cite_note-7http://en.wikipedia.org/wiki/Futures_contracts#cite_note-7http://en.wikipedia.org/wiki/Futures_contracts#cite_note-7http://en.wikipedia.org/wiki/Futures_contracts#cite_note-7http://en.wikipedia.org/wiki/Futures_contracts#cite_note-6http://en.wikipedia.org/wiki/Swing_tradinghttp://en.wikipedia.org/wiki/Day_tradershttp://en.wikipedia.org/wiki/Swap_%28finance%29http://en.wikipedia.org/wiki/Equity_derivativehttp://en.wikipedia.org/wiki/Interest_rate_swapshttp://en.wikipedia.org/wiki/Interest_rate_swapshttp://en.wikipedia.org/wiki/Farmerhttp://en.wikipedia.org/wiki/Commodity_markethttp://en.wikipedia.org/wiki/Consumer -
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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" 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 riskand time preferences, from a hedger to a speculator.
http://en.wikipedia.org/wiki/Futures_contracts#cite_note-7http://en.wikipedia.org/wiki/Mutual_fundhttp://en.wikipedia.org/wiki/Mutual_fundhttp://en.wikipedia.org/wiki/Separately_managed_accounthttp://en.wikipedia.org/wiki/Portfolio_managerhttp://en.wikipedia.org/wiki/Tracking_errorhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Time_preferencehttp://en.wikipedia.org/wiki/Time_preferencehttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Tracking_errorhttp://en.wikipedia.org/wiki/Portfolio_managerhttp://en.wikipedia.org/wiki/Separately_managed_accounthttp://en.wikipedia.org/wiki/Mutual_fundhttp://en.wikipedia.org/wiki/Mutual_fund -
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CONCLUSION
Trading in the futures market is risky. It can be quite complicated,
especially, for those who are still new to investing. While it is not for
everybody, the futures market can be suitable for a wide range of people.
For those who have already started investing in stocks or bonds, it would
be best to talk to your broker if you are interested in futures trading.
Here are the key points covered in this tutorial:
1. The futures market is a global marketplace.
2. The futures a market is all about trading futures contracts instead of
the physical commodities involved.
3. In the contract, it will state the price per unit, type, value, quality and
quantity of the commodity involved, as well as the month the contract
expires.
4. There are basically two players in the futures market: hedgers and
speculators. The hedger will, as much as possible, try to minimize
risk from the rising or declining prices. Speculators are the risk-
takers, who will try to profit from the rising or declining prices.
5. In the US, the futures markets are regulated by the CFTC and the
NFA.
6. Depending on the profits or losses incurred, a futures accounts can
be credited or debited on a day-to-day basis.
7. The futures market is characterized as being greatly leveraged due
to its margins. Leverage works both ways in that it can get you huge
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profits or huge losses (even greater than your initial investment) on
your futures investment.
8. There are 3 main strategies in futures trading: Going Long, Going
Short and Spreads.
9. Once you decide to trade in the futures market, there are 3
approaches used to participate in it: Managed Account, Commodity
Pool and Do-It-Yourself.
BIBLIOGRAPHY
1. WWW.GOOGLE.COM
2. WWW.WIKIPEDIA.COM
3. WWW.NSEINDIA.COM
4. WWW.DERIVATIVEINDIA.COM
5. WWW.FINANCEMONEY.IN
http://www.google.com/http://www.wikipedia.com/http://www.nseindia.com/http://www.derivativeindia.com/http://www.financemoney.in/http://www.financemoney.in/http://www.derivativeindia.com/http://www.nseindia.com/http://www.wikipedia.com/http://www.google.com/