Financial futures market . A futures contract is a corporate legal agreement between a buyer and a seller in which:
- The buyer agrees to accept delivery of something at a specified price at the end of a designated period.
- The seller agrees to deliver something at a specified price at the end of a designated period.
When speaking of the buyer or seller of a contract, the jargon of the futures markets is being adopted, which refers to the parts of the contract based on the future obligation, to which they are committing themselves. Like the value of the derivative futures contract of the value of the supporting asset, futures contracts are commonly called derivative assets. Of course, nobody buys or sells anything when they sign up for a futures contract. Instead, the parties to the contract agree to buy or sell for a specific amount, of something specific, at an agreed future date.
Summary
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- 1 Elements involved in a futures contract
- 2 Economic role of financial markets
- 3 Generalizations
- 4 Role of the clearing house in futures contracts
- 5 Margin requirements
- 6 Source
Elements involved in a futures contract
- Sustainer: it is the something that the parties agree to exchange.
- Future price: it is the price at which the parties agree to negotiate in the future.
- Established or deliverydate: is the designated date on which the parties agree to negotiate.
Futures contracts are products created by brokerage houses. For this, these houses must obtain government approval, as long as it shows that there is an economic purpose of the contract. Before 1972 only futures contracts involved traditional agricultural staples (grain and livestock) and industrial products. So they were called commodity futures. Futures contracts based on financial assets are called financial futures.
Economic role of financial markets
The basic economic function of financial futures markets is to provide an opportunity for participants in this market to protect themselves against the risk of adverse price movements. When an investor takes a position in the market by buying a futures contract (or agreeing to buy at a future date), he is said to be in a long position, or to have long futures. When an investor takes a position in the market to sell a futures contract (or agreeing to sell at a future date), he is said to be in a short position, or to have short futures.
Generalizations
- The buyer of a futures contract will make a profit if the futures price increases.
- The seller of a futures contract will make a profit if the futures price falls.
Most futures contracts have a settlement date in March, June, September or December. This means that at a certain period in the contract settlement month, the contract stops trading and the brokerage firm determines a settlement price. The contract with the closest settlement date is the closest futures contract. The next futures contract is one that is settled just after the close contract. The furthest contract at settlement time is the most distant futures contract.
A party to a futures contract has two choices in liquidating the position. First, the position can be liquidated before the cancellation date. For this purpose, the party must take a cancellation position in the same contract. For the buyer of a futures contract, it means selling the same number of identical futures contracts, for the seller of a futures contract, it means buying the same number of identical futures contracts.
The alternative is to wait until the settlement date. In that period, the buyer of the futures contract accepts the delivery of the breadwinner, the party that sells a futures contract liquidates the position, delivering the breadwinner at the agreed price.
Role of the clearing house in futures contracts
A clearing house is related to all futures brokerage houses, which performs various functions. One of these is to ensure that the parties to the transaction act. To see the importance of this function, consider the potential problems in the futures transaction described above, from the perspective of both parties.
Margin requirements
When taking a position in a futures contract, the investor must deposit a minimum amount of money per contract, as specified by the brokerage firm. This amount, called the initial margin, is required as a deposit on the contract. Individual brokerage firms are free to set margin requirements above the minimum established by the brokerage firm. The initial margin may be in the form of a foreign media value (eg, a Treasury note). As the price of futures contracts fluctuates for each day traded, the value of the investor’s shares in the position changes. The shares in a futures account is the sum of all the margins placed and all the daily gains, less all the daily losses in the account.
At the end of each trading day, the brokerage firm determines “the settlement price” of futures contracts. The closing price is the price of the financial asset at the end of the trading day (wherever trading during the day occurred). The brokerage house uses the settlement price to mark the investor’s position on the market, so that any gain or loss in the position is quickly reflected in the investor’s stock account.
Maintenance margin is the minimum level (specified by the brokerage house), at which the investor’s stock position may fall as a result of an unfavorable price movement, before the investor is required to deposit a additional margin. The additional margin deposited is called the variation margin and is an amount necessary to bring shares in the account to bring it to its initial level. The margin of variation should be in cash, rather than in instruments from other means. Any margin in excess of the amount can be withdrawn by the investor. If a party to a futures contract that is required to deposit a variation margin fails, by doing so within a 24-hour period, the brokerage firm closes the futures position.
