Chapter 17 Futures Terminology Forward an agreement calling for a future delivery of an asset at an agreed upon price Futures similar to forward but has standardized terms and is traded on an exchange Key difference in futures o Futures have secondary trading liquidity o Marked to market o Standardized contract terms such as delivery dates price units contract size o Clearinghouse guarantees performance The Futures price agreed upon price paid at maturity Long position Agrees to purchase the underlying asset at the stated futures price at contract maturity Short position Agrees to deliver the underlying asset at the stated futures price at contract maturity Profits on long and short positions at maturity o Long Futures price at maturity minus original futures price o Short Original futures price minus futures price at maturity o At contract maturity T FT ST F Futures price S spot price Clearinghouse acts as a party to all buyers and sellers A futures participant is obligated to make or take delivery at contract maturity Closing out positions Reversing the trade Take or make delivery Most trades are reversed and do not involve actual delivery Open Interest Open interest the total number of outstanding contracts o For every outstanding contract one investor is short there is another investor who is long o There is no double counting Open interest equals number of long positions or the number of short positions Trading volume this is different from the change in open interest If Bob liquidates his position by shorting to Mike there is one trade but no change in open interest The Margin Account Initial Margin funds that must be deposited in a margin account to provide capital to absorb losses Marking to Market each day the profits or losses are realized and reflected in the margin account Maintenance or variance margin an established value below which a trader s margin may not fall Margin call occurs when the maintenance margin is reached broker will ask for additional margin funds Stock Index Futures Available on both domestic and international stocks Several advantages over direct stock purchase lower transaction costs easier to implement timing or allocation strategies Long hedge An endowment fund will purchase stock in 3 months The manager buys futures now to protect against a rise in price Short hedge A hedge fund has invested in long term bonds and is worried that interest rates may increase Could sell futures to protect against a fall in price Hedging
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