Copyright © 2001 by Har court, Inc. All rights reserved. 1 Chapter 8: The Structure of Forward and Futures Markets An exchange floor is a crucible of ideas, markets, An exchange floor is a crucible of ideas, markets, events. Eventually ideas sprout from that for events. Eventually ideas sprout from that for improving a market or for whole new markets. improving a market or for whole new markets. Without ideas and the interchange of ideas, you’re Without ideas and the interchange of ideas, you’re never going to get an innovative process to work. never going to get an innovative process to work. Leo Melamed Leo Melamed Futures Futures , October 1996 , October 1996
Copyright © 2001 by Harcourt, Inc. All rights reserved.1 Chapter 8: The Structure of Forward and Futures Markets An exchange floor is a crucible of ideas,
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Copyright © 2001 by Harcourt, Inc. All rights reserved.
1
Chapter 8: The Structure of Forward and Futures Markets
An exchange floor is a crucible of ideas, markets, events. An exchange floor is a crucible of ideas, markets, events. Eventually ideas sprout from that for improving a market or Eventually ideas sprout from that for improving a market or for whole new markets. Without ideas and the interchange for whole new markets. Without ideas and the interchange of ideas, you’re never going to get an innovative process to of ideas, you’re never going to get an innovative process to work.work.
Leo MelamedLeo Melamed
FuturesFutures, October 1996, October 1996
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Important Concepts in Chapter 8 Definitions and examples of forward and futures contractsDefinitions and examples of forward and futures contracts Institutional characteristics of forward and futures marketsInstitutional characteristics of forward and futures markets Information on the futures contracts available for tradingInformation on the futures contracts available for trading Placing an order, margins, daily settlementPlacing an order, margins, daily settlement The role of the clearinghouseThe role of the clearinghouse Futures price quotationsFutures price quotations Magnitude and effects of transaction costsMagnitude and effects of transaction costs
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The Development of Forward and Futures Markets
Chicago Futures MarketsChicago Futures Markets The Development of Financial FuturesThe Development of Financial Futures The Parallel Development of Over-the-Counter MarketsThe Parallel Development of Over-the-Counter Markets
interbank marketinterbank market growth of forward marketsgrowth of forward markets
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The Over-the-Counter Forward Market
customizedcustomized privateprivate essentially unregulatedessentially unregulated credit riskcredit risk market size: $17 trillion face value, $430 billion market size: $17 trillion face value, $430 billion
market value at year-end 1999market value at year-end 1999
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Organized Futures Trading Contract DevelopmentContract Development Contract Terms and ConditionsContract Terms and Conditions
contract sizecontract size quotation unitquotation unit minimum price fluctuationminimum price fluctuation contract gradecontract grade trading hourstrading hours
Delivery TermsDelivery Terms delivery date and timedelivery date and time delivery or cash settlementdelivery or cash settlement
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Organized Futures Trading (continued)
Daily Price Limits and Trading HaltsDaily Price Limits and Trading Halts limit moveslimit moves circuit breakerscircuit breakers
Other Exchange ResponsibilitiesOther Exchange Responsibilities minimum financial responsibility requirementsminimum financial responsibility requirements position limitsposition limits rules governing the trading floorrules governing the trading floor
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Futures Exchanges
See See Table 8.1, p. 320Table 8.1, p. 320 for list of exchanges. for list of exchanges. Global and after-hours tradingGlobal and after-hours trading See See Figure 8.1, p. 321Figure 8.1, p. 321 for volume of futures trading. for volume of futures trading. See See Table 8.2, p. 322Table 8.2, p. 322 for volume by exchange. for volume by exchange.
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Futures Traders
General Classes of Futures TradersGeneral Classes of Futures Traders futures commission merchantsfutures commission merchants localslocals dual tradingdual trading
Classification by Trading StrategyClassification by Trading Strategy hedger/speculatorhedger/speculator spreaderspreader arbitrageurarbitrageur
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Futures Traders (continued) Classification by Trading StyleClassification by Trading Style
scalpersscalpers day tradersday traders position tradersposition traders
Off-Floor Futures TradersOff-Floor Futures Traders individualsindividuals institutionsinstitutions Introducing Broker (IB)Introducing Broker (IB) Commodity Trading Advisor (CTA)Commodity Trading Advisor (CTA) Commodity Pool Operator (CPO)Commodity Pool Operator (CPO) Associated Person (AP)Associated Person (AP)
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Futures Traders (continued)
The Cost and Profitability of Exchange MembershipThe Cost and Profitability of Exchange Membership seatsseats See See Figure 8.2, p. 326Figure 8.2, p. 326 for history of CBOT and CME for history of CBOT and CME
seat prices.seat prices. leasing a seat at around 1.0 - 1.5%/mo. of seat priceleasing a seat at around 1.0 - 1.5%/mo. of seat price profitability of membershipprofitability of membership
Forward Market TradersForward Market Traders over-the-counterover-the-counter primarily institutionsprimarily institutions
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11
The Mechanics of Futures Trading
Placing an OrderPlacing an Order pitpit open outcryopen outcry electronic systemselectronic systems
The Role of the ClearinghouseThe Role of the Clearinghouse See See Figure 8.3, p. 329Figure 8.3, p. 329.. margin depositsmargin deposits
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The Mechanics of Futures Trading (continued)
Daily SettlementDaily Settlement initial margininitial margin maintenance marginmaintenance margin concept of “margin” vs. performance bondconcept of “margin” vs. performance bond settlement pricesettlement price variation marginvariation margin See See Table 8.3, p. 331Table 8.3, p. 331 for example. for example. open interestopen interest
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The Mechanics of Futures Trading (continued)
Delivery and Cash SettlementDelivery and Cash Settlement three-day delivery processthree-day delivery process alternative deliverable gradesalternative deliverable grades offsettingoffsetting exchange for physicalsexchange for physicals forward market proceduresforward market procedures
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14
Futures Price Quotations
See See Figure 8.4, p. 336Figure 8.4, p. 336
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Types of Futures Contracts See See Table 8.4, p. 338Table 8.4, p. 338..
Grains and OilseedsGrains and Oilseeds Livestock and MeatLivestock and Meat Food and FiberFood and Fiber Metals and EnergyMetals and Energy MiscellaneousMiscellaneous Foreign CurrencyForeign Currency Treasury Bills and EurodollarsTreasury Bills and Eurodollars Treasury Notes and BondsTreasury Notes and Bonds Economic IndicesEconomic Indices Stock IndicesStock Indices
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Types of Futures Contracts (continued)
Managed FundsManaged Funds Hedge FundsHedge Funds Indices of Futures Market ActivityIndices of Futures Market Activity
See Table 8.5, p. 343 for most active U. S. contracts
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17
Transaction Costs in Forward and Futures Trading
CommissionsCommissions Bid-Ask SpreadBid-Ask Spread Delivery CostsDelivery Costs
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The Regulation of Futures Markets
The Commodity Futures Trading CommissionThe Commodity Futures Trading Commission Established 1974Established 1974 Responsibilities of CFTCResponsibilities of CFTC
ensuring public information availableensuring public information available authorization and licensing of contracts and authorization and licensing of contracts and
exchangesexchanges contract approvalcontract approval market surveillancemarket surveillance
Does not regulate forward marketDoes not regulate forward market
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The Regulation of Futures Markets (continued) The National Futures AssociationThe National Futures Association
Self-regulatory organizationSelf-regulatory organization Responsibilities includeResponsibilities include
prevention of fraud and manipulationprevention of fraud and manipulation protection of the public interestprotection of the public interest encouragement of free marketsencouragement of free markets arbitration of disputesarbitration of disputes
Regulation of Futures Markets WorldwideRegulation of Futures Markets Worldwide The Regulation of Futures Markets versus the Over-the-The Regulation of Futures Markets versus the Over-the-
Counter MarketCounter Market
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Summary
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Appendix 8A: Selected Financial Futures Contract Specifications
Appendix 8B: Taxation of Futures Contracts
Treated as 60 % capital gains and 40 % ordinary income.Treated as 60 % capital gains and 40 % ordinary income. Capital gains subject to 28 % maximum.Capital gains subject to 28 % maximum. Must be marked to market at year end.Must be marked to market at year end. Hedge transactions covered in Chapter 10.Hedge transactions covered in Chapter 10.
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