Futures Market and its Fundamentals: A futures market, also known as the exchange market is a platform where traders can trade and participate in the futures contracts of standards. It is the exchanges that define their values. These are a type of derivative contracts that are useful in selling, purchasing of commodities or any other financial asset or instrument. They get sold for a specific time of delivery in the future at a certain price.
The exchanges are crucial players in it which offer electronic and physical sites for trading, market data and price, settlement procedures, delivery procedures, margin mechanism, delivery times, exchange self-regulation and others among many services.
Organised as a Non-Profit
One can term and organise futures exchanges as profit or non-profit organisations. They are available for assimilation and integration under a brand name along with other exchanges. It includes the bond markets, stock market and options market.
The for-profit exchanges are all for clearing fees and earning as much revenue as they can.
On the other hand, non-profit exchanges of futures work for benefitting their members. They work as brokers and act as market makers who wish to garner revenue and earn a commission.
Some Top Futures Market
Here are top futures markets: CBOE (Chicago Board Options Exchange), NYMEX (New York Mercantile Exchange), CME(Chicago Mercantile Exchange), MGE (Minneapolis Grain Exchange).
These exchanges control the majority of futures trades across the global. Methods like open outcry, which has now run dry carried through such tradings. Trading pits were in the preferable zone for hand signalling during earlier days. They inhabited in financial hubs like London, New York and Chicago. But with the revolution of the internet and computers in every household, things became more accessible and utterly inclined towards digital.
Notably, CFTC (commodities futures clearing commission) is the primary regulating body in the US for the futures market and trading. Here, exchanges standardise the futures contracts. These markets have the ability to operate 24 hours a day.
Key to Futures Markets
A diver needs to try a jump in shallow waters before jumping into a deep sea. Similarly, a trader should know the basics of trading assets and futures contracts.
These contrasts came into existence to avert the ever-volatile market of commodities. Both suppliers and producers have an active involvement to make it a success. These parties have mutual negotiation before accepting the rewards and risks factors.
Some people find them a place for trading agricultural goods. Hence, they call it agrarian contracts. Here, the involvement of selling, buying and hedging remain in full force for financial products and values of interest rates for the futures.
The unique distinction between futures contracts and the rest of the securities is that the former can be created while the latter is issued. Interestingly, the futures market has a bigger size compared to commodity markets.
Illustration For The Futures Market
Suppose, there is a farm or a shop that sells corns for $ 5 per pound to a retailer. After that, the retailer charges $ 15 from people for the same quantity. Here, both are into profits. But to keep it going and intact, both need to pursue the fixed-rate tag. Here, it is an agreement between the farm holder and the retailer that if the rates of corns go below the set-rate, then the latter would pay extra money or the difference to compensate for the loss.
However, if the prices shot up, then, in that case, the investor gets to keep the profits.
Nature of Futures Contracts
The contracts trading on exchanges receive the standardisation from the exchange they trade on. The contract details need to be delivered like when, how and where the asset got bought or sold. Also, the quantity matters here. The contract has a mention of the type of currency the trade would commence. It has pieces of information about the expiry date, minimum tick value, and the last trading day.
There can be provisions in the standardised futures commodity regarding the adjustment on the contracted prices relying upon deviations due to the standard commodity.
A trader does not find any contract prior to the opening of the market on the first day of the new futures contract. All that is available are some specifications. There is a creation of contracts and no issuance. So, a party that goes long buys it from one which goes short, when traders resell for reducing their long position, the open interest slips. In another case, they rebuy in an attempt to cut their short positions.
Any speculator, who does not intend to take delivery of any futures contracts during the fluctuations of prices must take care to keep their position to zero before the contract ceases. After the expiry, the settlement of contracts will happen through cash or by physical delivery, precisely for the underlying commodities and finances.
The ultimate contracts lie between the exchange and the holders at the brink of expiry. Here, the original seller and buyers have a limited or no role to play. It is because the settling parties have no clue how many hands carried it to them.
The Margin Mechanism and Clearing
It is the clearinghouses that stand erected in the centre of every trade. The access to such legitimacy gets offered by futures exchanges. These houses have several tools to manage risks despite getting exposed to many trades on exchanges.
Working as a mediator, it takes the obligation of the parties willing to buy the commodity and sell it. Hence, the worry of both parties wears off. So, traders need to focus on the capability of clearinghouses to get their contracts fulfilled.
Clearinghouses have the authority to summon or issue margin calls demanding initial margin money from traders to deposit while opening a position. A margin is collateral, where traders holding any financial asset or instrument have to cover the hovering credit risks by depositing some money.
It is so that traders (buyers-sellers) on both ends have to deposit the initial margin. The clearinghouse keeps all the money safe. The remittance does not get transfer to other traders.
It calculates profits and losses daily through market-to market positions. Clearinghouses do so by keeping novice cost in the last day’s settlement value.
When traders go on a loss-making spree on their positions in a manner that their latest debits losses and the existing margin is below the maintenance margin at the day’s end, in that case, they are required to send a variation margin to a platform (exchange) which is responsible for passing that available fund as profits to traders who earned it. They are on the opposite side of the position.
Likewise, when the profit accumulated on a position by traders eclipse the margin balance and go beyond the maintenance margin, then the excess balance can be withdrawn by them.
The Need For Margin System
The system ensures that in the account of all parties decide to close their positions after the settlement of margin payments and variations; then, in that case, nobody would be required to make any further payment. The losing side would send all the payment to the winning side or the profiting side of the position well in advance.