FUTURES: CONTRACTUAL DETAILS
Introduction to Futures
A future is a standardized derivative contract between two parties: a buyer and a seller.
At the end of the life of the futures contract the buyer is obligated to pay the futures price (agreed upon at the time of entering into the futures contract) and receives, in exchange, the underlying asset or its cash equivalent.
Individual futures contracts specify whether or not the contract is cash settled (i.e. the cash equivalent of the underlying asset) or whether it is physically settled.
For example, most financial futures are cash settled e.g. the S&P500 index futures is cash settled as opposed to delivering the 500 stocks in the index. On the other hand the Kansas City Hard Red Winter Wheat futures, which has traded continuously since 1876, is physically settled for 5,000 bushels of wheat per contract.
Being a standardized contract means that the buyer and seller do not contract directly with each other. Instead, they contract with the intermediary known as the clearinghouse. The clearinghouse protects their potential liability by requiring that margin be deposited and all positions are marked-to-market on at least a daily basis. More frequent marking-to-market can occur on volatile days.
Marking-to-market
This a system whereby realized gains are recognized immediately by crediting them to the account of one party to the contract, and debiting to the account of the other party. That is, if the market value of the underlying falls below the obligated price then the buyer must pay this difference and the seller will receive this difference net of other margin requirements.
This means that if the price moves against one party they must ensure that there are sufficient funds to cover both margin and marking-to-market requirements on at least a daily basis.
In general, the terminal payoff from a long futures position with futures price equal to F and the current underlying asset value is S, can be written as follows:
S - F.
For a comprehensive guide to margins per futures market, see www.ftsweb.com and then click on Links to see margin rates.
Futures Quotations
It is important to know the contractual specifications of a futures contract in order to understand the meaning of the quotation.
For example, the oldest currently traded futures contract is the Kansas City Hard Red Winter Wheat Futures. Click on contractual details to see the details of this contract.
The
Symbol for this is KW and the remaining two letters + integer indicates the
contract's expiration month/year. On
Therefore, if the quote is 331 this implies 331 cents per bushel or 5000*3.31= $16,550 per contract.
Unfortunately, futures contracts typically have a quotation convention specific to the nature of the underlying asset being traded. However, operationally given the contractual details you can determine how they are quoted from the contractual specification in the same way as the above example.
The quickest method of checking the quote is usually obtained from the tick size and the fluctuation from 1 tick, which is generally provided as part of the contractual specification. So if 1/4 of a cent per bushel corresponds to $12.50, then each cent is $50.
Example: The S&P500 Index Futures trading on the Chicago Mercantile Exchange have a minimum fluctuation equal to 0.05 (i.e. 5 points). Thus, the total amount for the minimum fluctuation is $25 or $5 per point.
This is because the contract is $500*S&P500 Index number and so 0.05*$500 = $25 for 5 points. Thus a quotation of 1508.20 translates into a dollar price per contract equal to the 150820 points times $5. This is $754,100 for 1 futures contract.
For a comprehensive example on how to value an index future click on Stock Index Future Example now.
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