Tài chính doanh nghiệp - Chapter 8: Fundamentals of the futures market

© 2004 South-Western Publishing1Chapter 8Fundamentals of the Futures Market2OutlineThe concept of futures contractsMarket mechanicsMarket participantsThe clearing processPrinciples of futures contract pricingSpreading with commodity futures3The Concept of Futures ContractsIntroductionThe futures promiseWhy we have futures contractsEnsuring the promise is kept4IntroductionThe futures market enables various entities to lessen price risk, the risk of loss because of uncertainty over the future price of a commodity or financial assetAs with options, the two major market participants are the hedger and the speculator5The Futures PromiseIntroductionFutures compared to optionsFutures compared to forwardsFutures regulationTrading mechanics6IntroductionA futures contract is a legally binding agreement to buy or sell something in the future7Introduction (cont’d)The person who initially sells the contract promises to deliver a quantity of a standardized commodity to a designated delivery point during the delivery monthThe other party to the trade promises to pay a predetermined price for the goods upon delivery8Futures Compared to OptionsBoth involve a predetermined price and contract durationThe person holding an option has the right, but not the obligation, to exercise the put or the callWith futures contracts, a trade must occur if the contract is held until its delivery deadline9Futures Compared to ForwardsA futures contract is more similar to a forward contract than to an options contractsA forward contract is an agreement between a business and a financial institution to exchange something at a set price in the futureMost forward contracts involve foreign currency10Futures Compared to Forwards (cont’d)Forwards are different from futures because:Forwards are not marketableOnce a firm enters into a forward contract there is no convenient way to trade out of itForwards are not marked to marketThe two parties exchange assets at the agreed upon date with no intervening cash flowsFutures are standardized, forwards are customized11Futures RegulationIn 1974, Congress passed the Commodity Exchange Act establishing the Commodity Futures Trading Commission (CFTC) Ensures a fair futures market12Futures Regulation (cont’d)A self-regulatory organization, the National Futures Association was formed in 1982Enforces financial and membership requirements and provides customer protection and grievance procedures13Trading MechanicsMost futures contracts are eliminated before the delivery monthThe speculator with a long position would sell a contract, thereby canceling the long positionThe hedger with a short position would buy a contract, thereby canceling the short position14Trading Mechanics (cont’d)Gain or Loss on Futures Speculation Suppose a speculator purchases a July soybean contract at a purchase price of $6.12 per bushel. The contract is for 5,000 bushels of No. 2 yellow soybeans at an approved delivery point by the last business day in July. 15Trading Mechanics (cont’d)Gain or Loss on Futures Speculation (cont’d) Upon delivery, the purchaser of the contract must pay $6.12(5,000) = $30,600. At the delivery date, the price for soybeans is $6.16. This equates to a profit of $6.16 - $6.12 = $0.04 per bushel, or $200. If the spot price on the delivery date were only $6.10, the purchaser would lose $6.12 - $6.10 = $0.02 per bushel, or $100.16Why We Have Futures ContractsFutures contracts allow buyers and manufacturers to lock into prices and costs, respectivelyIf a firm wants gold, it buys contracts, promising to pay a set price in the future (long hedge)A gold mining company sells contracts, promising to deliver the gold (short hedge)17Ensuring the Promise is KeptThe Clearing Corporation ensures that contracts are fulfilledBecomes party to every tradeEnsures the integrity of the futures contractAssumes responsibility for those positions when a member is in financial distress18Ensuring the Promise is Kept (cont’d)Good faith deposits (or performance bonds) are required from every member on every contract to help ensure that members have the financial capacity to meet their obligations19Ensuring the Promise is Kept (cont’d)Selected Good Faith Deposit RequirementsData as of January 2, 2004 ContractSizeValueInitial Margin per ContractSoybeans5,000 bushels$39,700$1,620Gold100 troy ounces$41,600$2,025Treasury Bonds$100,000 par$108,000$2,565S&P 500 Index$250 x index$278,500$20,000Heating Oil42,000 gallons$38,346$3,37520Market MechanicsTypes of ordersAmbience of the marketplaceCreation of a contract21Types of OrdersA broker in commodity futures is a futures commission merchant (not the individual who places the order)When placing an order, the client should specify the type of order22Types of Orders (cont’d)A market order instructs the broker to execute a client’s order at the best possible price at the earliest opportunityWith a limit order, the client specifies a time and a priceE.g., sell five December soybeans at 540, good until canceled23Types of Orders (cont’d)A stop order becomes a market order when the stop price is touched during trading actionWhen executed, stop orders close out existing commodity positionsE.g., a short seller may use a stop order to protect himself against rising commodity prices24Ambience of the MarketplaceTrades occur by open outcry of the floor tradersTraders stand in a sunken pit and bark their offers to buy or sell at certain prices to othersTraders often use hand signals to signal their wishes concerning quantity, price, etc.On the pulpit, representatives of the exchange’s Market Report Department enter all price changes into the price reporting system25Ambience of the Marketplace (cont’d)The perimeter of the exchange is lined with hundreds of order desks, where telecommunications personnel from member firms receive orders from clients26Ambience of the Marketplace (cont’d)Jargon“See through the pit” means little trading activity“Acapulco trade” is an unusually large trade by someone who normally trades just a few contracts“Busted out” or “gone to Tapioca City” means traders incorrectly assess the market and lose all their capital27Ambience of the Marketplace (cont’d)Jargon (cont’d)“Fire drill” is a sudden rush of put activity for no apparent reason“Lights out” is a big price move“O’Hare Spread” refers to traders riding a winning streak28Creation of a ContractTwo traders confirm their trade verbally and with hand signalsEach of them fills out a cardOne side is blue for recording purchasesOne side is red for salesEach commodity has a symbol, and each delivery month has a letter code29Creation of a Contract (cont’d)At the conclusion of trading, traders submit their cards (their deck) to their clearinghouseIn 2003, nearly 7 million futures and options orders were electronically sent directly to floor brokers using special order receipts called electronic clerks30Market ParticipantsHedgersProcessorsSpeculatorsScalpers31HedgersA hedger is someone engaged in a business activity where there is an unacceptable level of price riskE.g., a farmer can lock into the price he will receive for his soybean crop by selling futures contracts32ProcessorsA processor earns his living by transforming certain commodities into another formPutting on a crush means the processor can lock in an acceptable profit by appropriate activities in the futures marketE.g., a soybean processor buys soybeans and crushes them into soybean meal and oil33SpeculatorsA speculator finds attractive investment opportunities in the futures market and takes positions in futures in the hope of making a profit (rather than protecting one)The speculator is willing to bear price riskThe speculator has no economic activity requiring use of futures contracts34Speculators (cont’d)Speculators may go long or short, depending on anticipated price movementsA position trader is someone who routinely maintains futures positions overnight and sometimes keep a contract for weeksA day trader closes out all his positions before trading closes for the day35ScalpersScalpers are individuals who trade for their own account, making a living by buying and selling contractsAlso called localsScalpers help keep prices continuous and accurate36Scalpers (cont’d)Scalping With Treasury Bond Futures Trader Hennebry just sold 5 T-bond futures to ZZZ for 77 31/32. Now, a sell order for 5 T-bond futures reaches the pit and Hennebry buys them for 77 30/32. Thus, Hennebry just made 1/32 on each of the 5 contracts, for a dollar profit of 1/32% x $100,000/contract x 5 contracts = $156.2537The Clearing ProcessMatching tradesAccounting supervisionIntramarket settlementSettlement pricesDelivery38Matching TradesEvery trade must be cleared by or through a member firm of the Board of Trade Clearing CorporationAn independent organization with its own officers and rules39Matching Trades (cont’d)Each trader is responsible for making sure his deck promptly enters the clearing processScalpers normally use only one clearinghouseBrokers typically submit their cards periodically while trading40Matching Trades (cont’d)After the Clearing Corporation receives trading cardsThe information on them is edited and checked by computerCards with missing information are returned to the clearing memberOnce all cards have been edited, the computer attempts to match cards for all trades that occurred that day41Matching Trades (cont’d)Mismatches (out trades) result in an Unmatched Trade Notice being sent to each clearing memberTraders must reconcile their out trades and arrive at a solution“House out” means an incorrect member firm is listed on the trading card“Quantity out” means the number of contracts is in dispute42Matching Trades (cont’d)After resolving all out trades, the computer prints a daily Trade RegisterShows a complete record of each clearing member’s trades for the dayContains subsidiary accounts for each customer clearing through the firm43Accounting SupervisionThe accounting problem is formidable because futures contracts are marked to market every dayOpen interest is a measure of how many futures contracts in a given commodity exist at a particular timeDifferent from trading volume since a single futures contract might be traded often during its life44Account Supervision (cont’d)Volume vs Open Interest for Soybean FuturesJune 16, 2000DeliveryOpenHighLowSettleChangeVolumeOpenJul 20005144514450405046-523200446746Aug 200050705074500450124788919480Sep 2000498049944950496044396015487Nov 20005020504249945006562262962655Jan 200151105130508451005410056305Mar 200152045204516051805410154987May 2001524052705230523044156202July 2001529053305280529040534187Nov 200153805400533053303037137145Intramarket SettlementCommodity prices may move so much in a single day that good faith deposits for many members are seriously eroded before the day endsThe president of the Clearing Corporation may issue a market variation call for members to deposit more funds into their account46Settlement PricesThe settlement price is analogous to the closing price on the stock exchangesThe settlement price is normally an average of the high and low prices during the last minute of tradingSettlement prices are constrained by a daily price limitThe price of a contract is not allowed to move by more than a predetermined amount each trading day47DeliveryDelivery can occur anytime during the delivery monthSeveral days are of importance:First Notice DayPosition DayIntention DaySeveral reports are associated with delivery:Notice of Intention to DeliverLong Position Report48Principles of Futures Contract PricingThe expectations hypothesisNormal backwardationA full carrying charge marketReconciling the three theories49The Expectations HypothesisThe expectations hypothesis states that the futures price for a commodity is what the marketplace expects the cash price to be when the delivery month arrivesPrice discovery is an important function performed by futuresThere is considerable evidence that the expectations hypothesis is a good predictor50Normal BackwardationBasis is the difference between the future price of a commodity and the current cash priceNormally, the futures price exceeds the cash price (contango market)The futures price may be less than the cash price (backwardation or inverted market)51Normal Backwardation (cont’d)John Maynard Keynes:Locking in a future price that is acceptable eliminates price risk for the hedgerThe speculator must be rewarded for taking the risk that the hedger was unwilling to bearThus, at delivery, the cash price will likely be somewhat higher than the price predicated by the futures market52A Full Carrying Charge MarketA full carrying charge market occurs when the futures price reflects the cost of storing and financing the commodity until the delivery monthThe futures price is equal to the current spot price plus the carrying charge:53A Full Carrying Charge Market (cont’d)Arbitrage exists if someone can buy a commodity, store it at a known cost, and get someone to promise to buy it later at a price that exceeds the cost of storageIn a full carrying charge market, the basis cannot weaken because that would produce an arbitrage situation54Reconciling the Three TheoriesThe expectations hypothesis says that a futures price is simply the expected cash price at the delivery date of the futures contractPeople know about storage costs and other costs of carry (insurance, interest, etc.) and we would not expect these costs to surprise the market55Reconciling the Three Theories (cont’d)Because the hedger is really obtaining price insurance with futures, it is logical that there be some cost to the insurance56Spreading with Commodity FuturesIntercommodity spreadsIntracommodity spreadsWhy spread in the first place?57Intercommodity SpreadsAn intercommodity spread is a long and short position in two related commoditiesE.g., a speculator might feel that the price of corn is too low relative to the price of live cattleRisky because there is no assurance that your hunch will be correct58Intercommodity Spreads (cont’d)With an intermarket spread, a speculator takes opposite positions in two different marketsE.g., trades on both the Chicago Board of Trade and on the Kansas City Board of Trade59Intracommodity SpreadsAn intracommodity spread (intermonth spread) involves taking different positions in different delivery months, but in the same commodityE.g., a speculator bullish on what might buy September and sell December60Why Spread in the First Place?Most intracommodity spreads are basis playsIntercommodity spreads are closer to two separate speculative positions than to a spread in the stock option senseIntermarket spreads are really arbitrage plays based on discrepancies in transportation costs or other administrative costs