Derivatives Demystified: A Step-by-Step Guide to Forwards, Futures, Swaps and Options

Chapter 4. Commodity and Bond Futures

INTRODUCTION

A futures contract is an agreement made through an organized exchange to buy or to sell a fixed amount of a commodity or a financial asset on a future date (or within a range of dates) at an agreed price. Unlike forward deals, which are negotiated directly between two parties, futures are standardized. Delivery is guaranteed by the clearing house associated with the exchange. A trader who contacts a broker and buys futures is said to have a long position. One who sells futures has a short position. The value of a trader's position is adjusted on a daily basis.

Futures are either traded by open outcry in trading pits in the form of an auction, or on electronic screen-based trading systems, although the latter is undoubtedly the way ahead. The Chicago exchanges currently (2003) operate both methods in tandem. In a pit-based market brokers transact buy and sell orders on behalf of clients including banks, corporations and private individuals; deals are also made by 'locals' who have purchased seats on the exchange in order to trade on their own account. As soon as a trade is agreed the details are entered into the exchange's price reporting system. Data from the exchanges are published throughout the world on websites and on electronic news services such as Reuters or Bloomberg. Nowadays, deals made in trading pits may be recorded on hand-held electronic devices rather than on the old cardboard tickets.

Both LIFFE and Eurex, the combined ...