Derivatives

CHAPTER 2Futures Markets

Aims

• To examine trading arrangements for futures contracts, including delivery of the underlying asset, margin requirements and closing out.
• To interpret futures quotes, including the settlement price and open interest.
• To discuss the different types of futures traders.

We have already discussed the basic principles behind forward and futures contracts. Forward contracts are analytically easier to deal with than futures contracts and so we often apply mathematical results from forwards (e.g. pricing forward contracts) to futures contracts. However, there are differences in practice between the two types of contract and we discuss the mechanics of both of these contracts in this chapter.

2.1 TRADING ON FUTURES MARKETS

Forward contracts are traded over-the-counter (OTC) whereas most futures are traded on an exchange and the differences between these two approaches are summarised in Table 2.1.

TABLE 2.1 Derivatives markets

Over-the-counter	Exchanges
Supplied by intermediaries (i.e. banks)  Customised to suit buyer  Can be done for any amount, and settlement date  Credit risk of counterparty and expensive to unwind  Allows anonymity – important for large deals  New contracts do not need approval of regulator	Traded on exchanges (e.g. NYSE-Euronext, CME)  Available for restrictive set of assets  Fixed contract sizes and settlement dates  Easy to reverse the position  Credit risk eliminated by clearing house margining system (‘marking-to-market’) ...