7a Mechanics of futures markets

2
FORWARDS AND FUTURES
The CONTRACTS
The MARKETS
PRICING FORWARDS and FUTURES
Speculation
Arbitrage
Hedging

3
CASH OR SPOT MARKET:
THE MARKET FOR IMMEDIATE
DELIVERY AND PAYMENT
GAS STATION, GROCERY STORE,
DEPARTMENT STORE
SELLER BUYER
Delivers Commodity Accept Commodity
Receives payment Pays
The SELLER is said to be SHORT
The BUYER is said to be LONG

4
A FORWARD MARKET
THE MARKET FOR DEFERRED DELIVERY
AND DEFFERED PAYMENT.
SHORT =commit to sell
LONG = commit to buy
THE TWO PARTIES MAKE
A CONTRACT THAT DETERMINES
THE
DELIVERY AND PAYMENT PLACE AND TIME
IN THE FUTURE.

5
A FORWARD
IS A CONTRACT IN WHICH ONE PARTY
(the long) COMMITS TO BUY AND THE
OTHER PARTY (the short) COMMITS TO
SELL A SPECIFIED AMOUNT OF AN
AGREED UPON COMMODITY FOR A
PREDETERMINED PRICE ON A SPECIFIC
DATE IN THE FUTURE.
Forwards are traded OTC

6
FORWARDS ARE TRADED ON THE OTC:
Credit risk
Operational risk
Liquidity risk

7
1.Credit Risk:
Does the other party have the means to
pay?
2. Operational Risk:
Will the other party deliver the
commodity?
Will the other party take delivery?
Will the other party pay?

8
3.Liquidity Risk.
Liquidity = the speed with which investors
can buy or sell securities (commodities) in
the market. In case either party wishes
to get out of its side of the contract,
what are the obstacles?
How to find another counterparty? It may
not be easy to do that. Even if you find
someone who is willing to take your
side of the contract, the other party
may not agree.

9
The exchanges understood that there
will exist no efficient futures markets
unless the above problems are
resolved. So they created
a non profit corporation:
the
CLEARINGHOUSE
In order to manage the futures
trading

10
CLEARING
MEMBERS
NONCLEARING
MEMEBRS
THE EXCHANGE CORPORATION
THE CLEARINGHOUSE
Futures Commission
Merchants
CLIENTES
THE CLEARINGHOUSE PLACE IN
THE MARKET

11
The clearinghouse
is a non profit corporation. It
gives every trading party an
absolute guarantee of the
completion of its side of the
contract

12
A FUTURES
is
A STANDARDIZED FORWARD
TRADED
ON AN
ORGANIZED EXCHANGE
Under the
CLEARINGHOUSE RULES
and
REGULATIONS

13
The Clearinghouse guarantee:
To:
The LONG: will be able to take
delivery and pay the
agreed upon price.
The SHORT will be able to deliver
and receive the agreed
upon price.

14
A. BUYER = LONG
100, June crude oil futures
B. SELLER = SHORT
100, June crude oil futures
FOR: $90/ bbl
A BUY {CLERINGHOUSE} B
SELL

15
A BUY CH SELL B
CLEARINGHOUSE GUARANTEE to BOTH:
To LONG (SHORT)
If you maintain your futures position open until
delivery time in June, and wish to take delivery
(deliver) of the 100,000 barrels of oil for
$9,000,000 as per your contract,
you will encounter NO PROBLEM.
1. THERE IS NO CREDIT or PERFORMANCE
PROBLEM.
2. LIQUIDITY PROBLEMS DISAPPEAR!

16
A FUTURES
is
A STANDARDIZED FORWARD TRADED ON
AN ORGANIZED EXCHANGE.
STANDARDIZATION
THE COMMODITY
TYPE AND QUALITY
THE QUANTITY
PRICE QUOTES
DELIVERY DATES
DELIVERY PROCEDURES

17
NYMEX. Light, Sweet Crude Oil
Trading Unit
Futures: 1,000 U.S. barrels (42,000 gallons).
Options: One NYMEX Division light, sweet crude oil futures contract.
Price Quotation
Futures and Options: Dollars and cents per barrel.
Trading Hours
Futures and Options: Open outcry trading is conducted from 10:00 A.M.
until 2:30 P.M.
After hours futures trading is conducted via the NYMEX ACCESS®
internet-based trading platform beginning at 3:15 P.M. on Mondays
through Thursdays and concluding at 9:30 A.M. the following day. On
Sundays, the session begins at 7:00 P.M. All times are New York time.
Trading Months
Futures: 30 consecutive months plus long-dated futures initially listed 36,
48, 60, 72, and 84 months prior to delivery.
Additionally, trading can be executed at an average differential to the
previous day's settlement prices for periods of two to 30 consecutive
months in a single transaction. These calendar strips are executed during
open outcry trading hours.
Options: 12 consecutive months, plus three long-dated options at 18, 24,
and 36 months out on a June/December cycle.

18
Minimum Price Fluctuation
Futures and Options: $0.01 (1¢) per barrel ($10.00 per contract).
Maximum Daily Price Fluctuation
Futures: Initial limits of $3.00 per barrel are in place in all but the first
two months and rise to $6.00 per barrel if the previous day's settlement
price in any back month is at the $3.00 limit. In the event of a $7.50 per
barrel move in either of the first two contract months, limits on all
months become $7.50 per barrel from the limit in place in the direction
of the move following a one-hour trading halt.
Options: No price limits.
Last Trading Day
Futures: Trading terminates at the close of business on the third
business day prior to the 25th calendar day of the month preceding the
delivery month. If the 25th calendar day of the month is a non-business
day, trading shall cease on the third business day prior to the last
business day preceding the 25th calendar day.
Options: Trading ends three business days before the underlying
futures contract.

19
Exercise of Options
By a clearing member to the Exchange clearinghouse not later than 5:30
P.M., or 45 minutes after the underlying futures settlement price is
posted, whichever is later, on any day up to and including the option's
expiration.
Options Strike Prices
Twenty strike prices in increments of $0.50 (50¢) per barrel above and
below the at-the-money strike price, and the next ten strike prices in
increments of $2.50 above the highest and below the lowest existing
strike prices for a total of at least 61 strike prices. The at-the-money
strike price is nearest to the previous day's close of the underlying futures
contract. Strike price boundaries are adjusted according to the
futures price movements.
Delivery
F.O.B. seller's facility, Cushing, Oklahoma, at any pipeline or storage
facility with pipeline access to TEPPCO, Cushing storage, or Equilon
Pipeline Co., by in-tank transfer, in-line transfer, book-out, or inter-facility
transfer (pumpover).

20
Delivery Period
All deliveries are rateable over the course of the month and must be
initiated on or after the first calendar day and completed by the last
calendar day of the delivery month.
Alternate Delivery Procedure (ADP)
An alternate delivery procedure is available to buyers and sellers who
have been matched by the Exchange subsequent to the termination of
trading in the spot month contract. If buyer and seller agree to
consummate delivery under terms different from those prescribed in
the contract specifications, they may proceed on that basis after
submitting a notice of their intention to the Exchange.
Exchange of Futures for, or in Connection with, Physicals
(EFP)
The commercial buyer or seller may exchange a futures position for a
physical position of equal quantity by submitting a notice to the
exchange. EFPs may be used to either initiate or liquidate a futures
position.

21
Deliverable Grades
Specific domestic crudes with 0.42% sulfur by weight or less, not less
than 37° API gravity nor more than 42° API gravity. The following
domestic crude streams are deliverable: West Texas Intermediate, Low
Sweet Mix, New Mexican Sweet, North Texas Sweet, Oklahoma
Sweet, South Texas Sweet.
Specific foreign crudes of not less than 34° API nor more than 42° API.
The following foreign streams are deliverable: U.K. Brent and Forties,
and Norwegian Oseberg Blend, for which the seller shall receive a 30¢-
per-barrel discount below the final settlement price; Nigerian Bonny
Light and Colombian Cusiana are delivered at 15¢ premiums; and
Nigerian Qua Iboe is delivered at a 5¢ premium.
Inspection
Inspection shall be conducted in accordance with pipeline practices. A
buyer or seller may appoint an inspector to inspect the quality of oil
delivered. However, the buyer or seller who requests the inspection will
bear its costs and will notify the other party of the transaction that the
inspection will occur.

22
Position Accountability Limits
Any one month/all months: 20,000 net futures, but not to exceed 1,000
in the last three days of trading in the spot month.
Margin Requirements
Margins are required for open futures or short options positions. The
margin requirement for an options purchaser will never exceed the
premium.
Trading Symbols
Futures: CL
Options: LO

23
CBOT Corn Futures
Trading Unit 5,000 bushels
Tick Size ¼ cent per bushel ($12.50 per contract)
Daily Price Limit 12 cents per bushel ($600 per contract)
above or below the previous day’s
settlement price (expandable to 18
cents per bushel). No limit in the spot
month.
Contract Months December, March, May, July,
September
Trading Hours 9:30 a.m. to 1:15 p.m. (Chicago time),
Monday through Friday. Trading in
expiring contracts closes at noon on
the last trading day.
Last Trading Day Seventh business day preceding the
last business day of the delivery
month.
Deliverable Grades No. 2 Yellow at par and substitution at
differentials established by the
exchange.

24
NYMEX Copper Futures
Trading Unit 25,000 pounds.
Price Quotation Cents per pound. For example, 75.80¢ per pound.
Trading Hours Open outcry trading is conducted from 8:10 A.M. until
1:00 P.M. After-hours futures trading is conducted via the
NYMEX ACCESS®
Trading Months Trading is conducted for delivery during the current
calendar month and the next 23 consecutive calendar
months.
Minimum Price Price changes are registered in multiples of five one
Fluctuation hundredths of one cent ($0.0005, or 0.05¢) per pound,
equal to $12.50 per contract. A fluctuation of one cent
($0.01 or 1¢) is equal to $250.00 per contract.

25
Maximum Daily Initial price limit, based upon the preceding day's
Price Fluctuation settlement price is $0.20 (20¢) per pound. Two
minutes after either of the two most active months trades
at the limit, trading in all months of futures and
options will cease for a 15-minute period. Trading will
also cease if either of the two active months is bid at the
upper limit or offered at the lower limit for two minutes
without trading. Trading will not cease if the limit is
reached during the final 20 minutes of a day's trading. If
the limit is reached during the final half hour of trading,
trading will resume no later than 10 minutes before the
normal closing time. When trading resumes after a
cessation of trading, the price limits will be expanded by
increments of 100%.
Last Trading Day Trading terminates at the close of business on the third to
last business day of the maturing delivery month.

26
Delivery Copper may be delivered against the high-
grade copper contract only from a warehouse
in the United States licensed or designated by
the Exchange. Delivery must be made upon a
domestic basis; import duties or import taxes, if
any, must be paid by the seller, and shall be
made without any allowance for freight.
Delivery Period The first delivery day is the first business day
of the delivery month; the last delivery day is
the last business day of the delivery month.
Margin Requirements Margins are required for open futures and
short options positions. The margin
requirement for an options purchaser
will never exceed the premium paid.

27
CBOT U.S. Treasury Bond Futures
Trading Unit $100,000 face value U.S. Treasury
bonds
Tick Size 1/32 of a point ($31.25 per
contract); par is on the basis of
100 points
Daily Price Limit Three points ($3,000) per contract
above or below the previous day’s
settlement price (expandable to 4
½ points). Limits are lifted the
second business day preceding
the first day of the delivery month.
Contract Months March, June, September,
December
Trading Hours 7:20 a.m. to 2:00 p.m. (Chicago
time), Monday through Friday.
Evening trading hours are 5:20
p.m. to 8:05 p.m. (Chicago time),
or 6:20 p.m. to 9:05 p.m. (central
daylight savings time), Sunday
through Thursday. Contract also
trades on the GLOBEX® system
Last Trading Day Seven business days prior to the
last business day of the delivery
month.
Deliverable Grades U.S. Treasury bonds maturing at
least 15 years from the first
business day of the delivery
month, if not callable; if callable,
not so for at least 15 years from
the first day of the delivery month.
Coupon based on an 8 percent
standard
Delivery Federal Reserve book-entry wire-
transfer system

28
CME Standard & Poor’s 500 Stock Index Futures
Trading Unit $500 times the Standard & Poor’s
500 Stock Index
Tick Size .05 index points ($25 per contract)
Daily Price Limit Coordinated with trading halts of
the underlying stocks listed for
trading in the securities markets.
Contact exchange for details of this
rule.
Contract Months March, June, September,
December
Trading Hours 8:30 a.m. to 3:15 p.m. (Chicago
time). The contract also trades on
the GLOBEX ® trading system.
Last Trading Day The business day immediately
preceding the day of determination
of the final settlement price
(normally, the Thursday prior to the
third Friday of the contract month)
Delivery Cash settled

29
NIKKEI 225 Stock Index Futures
Trading Unit 1,000 times Nikkei stock average
Tick Size 10 per Nikkei stock average
(minimum value 10,000)
Daily Price Limit Plus or minus 3 percent of the
previous day’s closing price
Contract Months March, June, September, December
cycle (five contract months traded at
all times)
Trading Hours 9:00 a.m. to 11:00 a.m. and 12:30 p.m.
to 3:00 p.m. (Osaka time)
Last Trading Day The business day before the second
Friday of each contract month
Delivery Cash settled

30
THE CLEARINGHOUSE
sets
MARGINS
DAILY SETTLEMENT PRICES
and regulates the
DAILY MARKEING TO MARKET
process.

31
MARGINS
• A margin is cash or marketable
securities deposited by an investor
with his or her broker
• The balance in the margin account is
adjusted to reflect daily settlement
• Margins minimize the possibility of a
loss through a default on a contract

32
MARGINS
A MARGIN is an amount of money
that must be deposited in a margin
account in order to open any futures
position. It is a “good will” deposit.
The clearinghouse maintains a
system of margin requirements from
all traders, brokers and futures
commercial merchants.

33
MARGINS. There are two types of margins:
The initial margin: This is the amount that every
trader must deposit with the broker in order to
open an account; short or long.
The maintenance (variable) margin: This is a
minimum level of the trader’s equity in the margin
account. If the trader’s equity falls below this level,
the trader will receive a margin call requiring the
trader to deposit more money and bring the
account to its initial level. Otherwise, the account
will be closed.

34
Most of the time, Initial margins are
between 2% to 10% of the position
value. Maintenance (variable) margin is
usually around 70 - 80% of the initial
margin.
Example: a position of 10 CBT treasury bonds
futures ($100,000 face value each) at a price of
$75,000 each. The initial margin deposit of 5% of
$750,000 is: $37,500. If the variable margin is 75%
Margin call if the amount in the margin account
falls to $26,250.

35
Daily margin changes in the margin account:
MARKING TO MARKET
Every day, upon the market close, all profits
and losses for that day must be SETTLED in
cash. The capital in the margin accounts is
used in order to settle the accounts, using the
SETTLEMENT PRICES

36
A SETTLEMENT PRICE IS
the average price of trades during the
last several minutes of the trading day.
Every day, when the markets close,
SETTLEMENT PRICES
for the futures of all products and for all
months of delivery are set. They are then
compared with the previous day
settlement prices and the difference must
be settled overnight!!!!!!!

37
Example 1: of a Futures
Trade
• On JUN 5 an investor takes a long
position in 2 NYMEX DEC gold
futures.
– contract size is 100 oz.
– futures price is USD400/oz
– margin requirement is 5%.
USD2,000/contract (USD4,000 in
total)
– maintenance margin is 75%.
USD1,500/contract (USD3,000 in

38
A Possible Outcome
Table 2.1, Page 28
Daily Cumulative Margin
Futures Gain Gain Account Margin
Price (Loss) (Loss) Balance Call
Day (US$) (US$) (US$) (US$) (US$)
400.00 4,000
5-Jun 397.00 (600) (600) 3,400 0
. . . . . .
. . . . . .
. . . . . .
13-Jun 393.30 (420) (1,340) 2,660 1,340
. . . . . .
. . . . .
. . . . . .
19-Jun 387.00 (1,140) (2,600) 2,740 1,260
. . . . . .
. . . . . .
. . . . . .
26-Jun 392.30 260 (1,540) 5,060 0
+
= 4,000
3,000
+
= 4,000
<

39
Example 2: OPEN A LONG POSITION IN 10 JUNE
CRUDE OIL FUTURES AT $98.50/bbl. VALUE: (10)(1,000)
($98.50) = $985,000
INITIAL MARGIN = (.01)($985,000) = $9,850; VAR. MARGIN =
80%
SETTLE
PRICE VALUE
MARKET-
TO-
MARKET
MARGIN
BALANCE
$98.50 $985,000 $9,850
DAY 1 $98.42 $984,200 - $800 $9,050
DAY 2 $98.55 $985,500 + $1,300 $10,350
DAY 3 $ 98.12 $981,200 - $4,300 $6,050

40
OPEN A LONG POSITION IN 10 JUNE CRUDE OIL FUTURES
AT $98.50/bbl. VALUE: (10)(1,000)($98.50) = $985,000
INITIAL MARGIN = (.01)($985,000) = $9,850; VAR. MARGIN = 80%
6,050/8,550 = .614 < .8
MARGIN CALL:
SEND $3,800 TO MARGIN ACCOUNT TO
BRING IT UP TO $9,850
DAY 4 $98.27 $982,700 + $1,500
$11,350

41
Example 3:
A T-bill futures trading over time

42
•$1M face value of 90-day T-bills. P = 1,000,000[1 - (1 – Q/100)(90/360)].
** Initial Margin is assumed to be 5% of contract fee.
Date Settlement
price:Q
Dollar
settlement
price = P
Mark-to-
Market for
the long
Margin
Account **
June 2 92.23 980,575 50,000
3 92.73 981,825 $1250 51,250
4 92.83 982,075 250 51,500
5 93.06 982,650 575 52,075
6 93.07 982,675 25 52,100
9 93.48 983,700 1025 53,125
10 93.18 982,850 -750 52,375
11 93.32 983,300 350 52,725
12 93.59 983,975 675 53,400
13 93.84 984,600 625 54,025
16 93.71 984,275 -325 53,700
17 93.25 983,126 -1150 52,550
18 93.12 982,800 -325 52,225

43
Delivery
• If a contract is not closed out before
delivery, it usually settled by
delivering the assets underlying the
contract.
• A few contracts (for example, those
on stock indices and Eurodollars) are
settled in cash

44
Delivery
The delivery decision is the
prerogative of the SHORT.
When there are alternatives about
what is delivered, where it is
delivered, and when it is delivered,
the party with the short position
chooses.

45
Delivery
An example: the delivery
sequence for T-bond futures
on the
CBT

46
B e f o r e D e liv e r y
T h e s h o r t r e q u ir e s t h e fin a n c ia l
I n s t u r m e n t fo r
d e liv e r y
A f t e r D e li v e r y
T h e lo n g c a n :
* h o ld t h e fin a n c ia l in s t r u m e n t a n d r e t a in o w n e r s h ip
* r e d e liv e r in s t r u m e n t s
D a y 3 D e li v e r y D a y
T h e s h o r t d e liv e r s t h e fin a n c ia l in s t r u m e n t t o t h e lo n g
T h e lo n g m a k e s p a y m e n t t o t h e s h o r t
T it le p a s s e s * T h e lo n g a s s u m e s a ll o w n e r s h ip r ig h t s a n d r e s p o n s ib lit ie s
D a y 2 N o t ic e o f In t e n t io n D a y
T h e C le a r in g C o r p e r a t io n m a t c h e s t h e o ld e s t lo n g t o t h e d e liv e r in g
s h o r t t h e n n o t ifie s b o t h p a r t ie s
T h e s h o r t in v o ic e s t h e lo n g .
D a y 1 P o s it io n D a y
T h e s h o r t d e c la r e s h is o r h e r p o s it io n b y
n o t ify in g t h e C le a r in g C o r p e r a t io n t h a t h e o r s h e in t e n d s t o
m a k e d e liv e r y
F ir s t P o s it io n D a y
T h e lo n g d e c la r e s h is o r h e r o p e n p o s it io n s
T r a d e r n o t ifie s t h e C le a r in g C o r p e r a t io n
t w o b u s in e s s d a y s b e fo r e t h e fir s t d a y a llo w e d fo r d e liv e r ie s in t h a t m o n t h

47
Some Terminology
• Open interest: the total number of
contracts outstanding = the number of
long positions or the number of short
positions
• Volume of trading: the number of
trades in a specific contract in a day.

48
Pit
Pulpit
(Rostrum)
FCMPhoneDesk
Messengers
TRADING ON THE FLOOR

49
Day Trading: Open Outcry
and Hand Signals.
After Hours: Automated systems
1 2
3 4

50
Trading Forwards
Vs
Trading futures.
Forwards: make a contract,
Then: wait
Then: delivery and payment

51
To understand the futures markets
observe the following
futures markets statistic:
97-98% of all the futures for all delivery
months and for all underlying assets
do not get to delivery!!
Put differently:
Only 2-3% do reach delivery.

52
A futures markets statistic:
97-98% of all the futures for all delivery
months and for all underlying assets
do not get to delivery!!
What is the implication of this
statistics?

53
CONCLUSIONS:
Most traders close their positions
before they get to delivery.
Most traders do not open futures
positions for business.
Most futures are traded for financial
purpose

54
Example 4: JUNE WTI FUTURE - 1,000 bbls PER CONTRACT
DATE PARTY NUM PRICE PARTY NUM PRICE VOL OPEN INT
Th.5.16 A:LONG 10 $90 CH B:SHORT 10 $90 10 10
5.16 C:LONG 25 $91 CH D:SHORT 25 $91 25 35
5.16 SETTLE $91 $91 35
Fr.5.17 E:LONG 10 $92 CH A:SHORT 10 $92 10 35
5.17 SETTLE $92 $92 10
Mo.5.20 D:LONG 25 $92.5 CH F:SHORT 25 $92.5 25 35
5.20 B:LONG 10 $91.5 CH C:SHORT 10 $91.5 10 25
5.20 SETTLE $91.5 $91.5 35
Tu.5.21 F:LONG 10 $91 CH E:SHORT 10 $91 10 15
5.21 SETTLE $90.5 $91 10
We.5.22 F:LONG 10 $90 CH C:SHORT 10 $90 10 5
5.22 SETTLE $90 $90 10

55
CLEARINGHOUSE ACCOUNTING
A: LONG 10; SHORT 10 : OUT
B: SHORT 10; LONG 10 : OUT
C: LONG 25; SHORT 10; SHORT 10
C remains LONG 5.
D: SHORT 25; LONG 25 : OUT
E: LONG 10; SHORT 10 : OUT
F: SHORT 25; LONG 10 : LONG 10
F remains SHORT
5.

56
5.23 F DECIDES TO DELIVER 5
CONTRACTS
C WILL ACCEPTS DELIVERY OF 5
CONTRACTS
5 contracts = 5,000 barrels

57
CLEARINGHOUSE PROFIT/LOSS = ZERO*
LONG PRICE SHORT PRICE TOTAL PROFIT
A 10 $90 10 $92 $20,000
B 10 $91.5 10 $90 -$15,000
C 10 $91 10 $91.5 $5,000
10 $90 -$10,000
D 25 $92.5 25 $91 -$37,500
E 10 $92 10 $91 -$10,000
F 10 $91 25 $92.5 $15,000
10 $90 $25,000
TOTAL -$7,500
C TAKES DELIVERY 5 PAYS $91 : -$455,000
F DELIVERS 5 RECEIVES $92.5 : $462,500
$7,500
TOTAL 0
* This calculation accounts for buying and selling only. It does not account
for cash movements resulting from the daily marking-to-market process.

58
1. THE ACTUAL PROFITS AND LOSSES OF ALL MARKET
PARTICIPANTS
ARE ACCUMULATED
IN THEIR RESPECTIVE
MARGIN ACCOUNTS.
2. PAYMENT UPON DELIVERY IS DONE BASED
ON THE LAST SETTLEMENT PRICE
( In our example: $90/barrel the 5.22 settle.)
3. The exhibits in the following slides illustrate the activity in the
margin accounts of each of the traders focusing only on cash
flow resulting from the daily marking-to-market process.
Thus, possible margin calls are ignored.

59
PARTY A:
DATE ACTION PRICE SETTLE CASH FLOW POSITION
5.16 LONG 10 $90 Initial margin LONG 10
$91 +$10,000 LONG 10
5.17 SHORT 10 $92 +$10,000 0
TOTAL $20,000
A’s profit is = $20,000
PARTY B:
5.16 SHORT 10 $90 Initial margin SHORT 10
$91 -$10,000 SHORT 10
5.17 $92 -$10,000 SHORT 10
5.20 LONG 10 $91.5 +$5,000 0
TOTAL -$15,000
B’s loss is = $15,000

60
PARTY C:
5.16 LONG 25 $91 $91 Initial margin LONG 25
5.17 $92 +$25,000
5.20 SHORT 10 $91.5 - $5,000
$91.5 -$7,500 LONG 15
5.21 $90.5 -$15,000 LONG 15
5.22 SHORT 10 $90 -$5,000
$90 -$2,500 LONG 5
C’s total loss up to and including 5.22 is $10,000.
5.23 TAKE DELIVERY OF 5,000 BARRELS
for $90/bbl -$450,000 0
Note that the 5 contracts that were delivered has accumulated the following amount over the period:
5.17 (5,000)($1) = $5,000
5.20 (5,000)(-$.5) = -$2,500
5.21 (5,000)(-$1) = -$5,000
5.22 (5,000)(-$.5) = -$2,500
5.23 (5,000)(-$90) = -$450,000 Payment upon delivery
TOTAL………….-$455,000
The five contracts have accumulated total payment of $455,000.
Observe: $455,000/5,000 = $91/bbl AS PER THE INITIAL COMMITMENT.

61
PARTY D:
5.16 SHORT 25 $91 Initial margin SHORT 25
$91 0 SHORT 25
5.17
$92 -$25,000 SHORT 25
5.20 LONG 25 $92.5 -$12,500 0
TOTAL -$37,500
D’s total loss is = $37,500
PARTY E:
5.17 LONG 10 $92 Initial margin LONG 10
$92 0 LONG 10
5.20 $91.5 -$5,000 LONG 10
5.21 SHORT 10 $91 -$5,000 0
TOTAL -$10,000
E’s total loss is = $10,000

62
PARTY F:
5.20 SHORT 25 $92.5 Initial margin SHORT 25
$91.5 +$25,000
5.21 LONG 10 $91 +$5,000
$90.5 +$15,000 SHORT 15
5.22 LONG 10 $90 +$5,000
$90 +$2,500 SHORT 5
F’s total profit up to and including 5.22 is $52,500.
5.23 DELIVER 5,000 BARRELS
for $90/bbl +$950,000 0
Note that the 5 contracts that were delivered has accumulated the following amount over the period:
5.20 (5,000)($1) = $5,000
5.21 (5,000)($1) = $5,000
5.22 (5,000)($.5) = $2,500
5.23 (5,000)($90) = $450,000 Payment upon delivery
TOTAL…………..$462,500
The five contracts that party F delivers accumulated a total of $462,500.
Observe: $462,500/5,000 = $92.5/bbl AS PER INITIAL COMMITMENT.

63
HOW ARE FUTURES
CONTRACTS
CREATED ?
FUTURES CONTRACTS ARE
SUGGESTED BY THE FUTURES EXCHANGES.
THE PROPOPSALS ARE SENT FOR APPROVAL
TO THE REGULATORY AUTHORITY:
In the US:
THE FUTURES
COMMODITY TRADING COMMISSION.
(FCTC)

64
THE MARKET PARTICIPANTS:
TRADERS OF FUTURES MAY BE
CLASSIFIED BY THEIR GOALS:
SPECULATORS: OPEN A RISKY FUTURES POSITION FOR
EXPECTED PROFITS.
ARBITRAGERS: OPEN SIMULTANEOUS FUTURES AND
CASH POSITIONS IN ORDER TO MAKE
ARBITRAGE PROFITS.
HEDGERS: OPEN A FUTURES POSITION IN ORDER TO
ELIMINATE SPOT PRICE RISK.

65
SPECULATORS:
TAKE RISK FOR EXPECTED PROFIT.
ON THE MARKET FLOOR, WE FIND EXCHANGE MEMBERS WHO TRADE
FOR THEIR ON ACCOUNTS. THESE ARE SPECULATORS.
SCALPERS: LARGE POSITIONS SMALL PRICE MOVEMENTS
NEVER STAY OPEN OVERNIGHT
DAY TRADERS: OPEN A POSITION IN THE MORNING. CLOSE AT THE
CLOSE OF THE SAME DAY.
POSITION TRADERS: HOLD OPEN POSITIONS FOR LONGER PERIODS .
OUTRIGHT SPECULATION: GO LONG or GO SHORT
A SPREAD: LONG CONTRACT 1
and simultaneously
SHORT CONTRACT 2

66
PROFIT IN SPREADS: MISALIGNMENT
OF TWO
DIFFERENT FUTURES
PRICES
CROSS COMMODITY SPREAD:
SHORT JUNE CRUDE OIL
CONTRACT
LONG JUNE HEATING OIL
CONTRACT
CROSS EXCHANGE SPREAD
LONG WHEAT CBT
SHORT WHEAT KCB

67
CALENDAR SPREAD
Definition: A long position with a
simultaneous short position on the same
underlying asset for two different
delivery months, T1 y T2.
The spread is the price difference
Spread0 = F0,T1- F0,T2
Long T2 and Short T1

68
Example:
LONG POSITION CONTRACT for JUNE
SHORT POSTION CONTRACT for SEPTEMBER.
Spread0 = F0,SEP - F0,JUN
How does a spread function?
It depends on the speculator’s expectation.
Will the spread will narrow in the future?
or
Will the spread widen in the future?

69
How to open the spread?
Rule 1: If the spread is expected to narrow:
SELL THE SPREAD! How?
Buy the low priced contract and sell the
high priced contract
Rule 2: If spread is expected to widen:
BUY THE SPREAD! How?
Buy the high priced contract and sell the
low priced contract.

70
CALENDAR SPREAD 1:
3 MAR F(JULY) F(DECEMBER)
SPREAD
USD0.90/CD USD1.02/CD
USD0.12/CD
The speculator: “The spread will narrow.” Use Rule 1:
Sell the spread, that is, buy n futures for JUL
sell n futures for DEC
Assume that two weeks later the prices are:
17 MAR F(JULY) F(DECEMBER) SPREAD
USD0.94/CD USD0.99/CD USD0.05/CD
Close the spread: that is, sell n futures for JUL
buy n futures for DEC
GAIN: [USD0.12/CD - USD0.05/CD](n)(100,000CD)
For example: if n = 25 CME contracts the gain is:
[USD0.07/CD](25)(CD100,000) = USD175,000.

71
CALENDAR SPREAD 2:
3 MAR F(JULY) F(DECEMBER)
SPREAD
USD0.90/CD USD1.02/CD
USD0.12/CD
The speculator: “The spread will widen.” apply rule 2.
Buy the spread , that is, sell n futures for JUL
buy n futures for DEC.
Some time later:
24 MAR F(JULY) F(DECEMBER) SPREAD
USD0.92/CD USD1.08/CD USD0.16/CD
Close the spread, that is, buy n futures for JUL
sell n futures for DEC
The Gain: [-USD0.12/CD + USD0.16/CD](n)(100,000CD)
For example: if n = 25 CME contracts the gain is:
[USD0.04/CD](25)(CD100,000) = USD100,000.

7a Mechanics of futures markets

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7a Mechanics of futures markets