Ch02HullOFOD9thEdition.pptx
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Chapter 2 Mechanics of Futures Markets Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 1 Futures Contracts Available on a wide range of assets Exchange traded Specifications need to be defined: What can be delivered, Where it can be delivered, & When it can be del...
Chapter 2 Mechanics of Futures Markets Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 1 Futures Contracts Available on a wide range of assets Exchange traded Specifications need to be defined: What can be delivered, Where it can be delivered, & When it can be delivered Settled daily (marked to market) Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 2 Convergence of Futures to Spot (Figure 2.1, page 29) Futures Price Spot Price Futures Price Spot Price Time (a) Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 Time (b) 3 Convergence of Futures to Spot The difference between the spot and future prices is called the basis and is given by Basis=Spot price – Future price As the maturity date approaches, the basis converges to zero. At expiration the spot price must be equal to the future price because the future price has become the price today for delivery today, which is the same as the spot thus, arbitragers will force the prices to be the same at expiration 4 Margins A margin is cash or marketable securities deposited by an investor with his or her broker The balance in the margin account is adjusted to reflect daily settlement Margins minimize the possibility of a loss through a default on a contract Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 5 Margin Cash Flows A trader has to bring the balance in the margin account up to the initial margin when it falls below the maintenance margin level A member of the exchange clearing house only has an initial margin and is required to bring the balance in its account up to that level every day. These daily margin cash flows are referred to as variation margin A member is also required to contribute to a default fund Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 6 Example of a Futures Trade (page 27-29) An investor takes a long position in 2 December gold futures contracts on June 5 contract size is 100 oz. futures price is US$1,450 initial margin requirement is US$6,000/contract (US$12,000 in total) maintenance margin is US$4,500/contract (US$9,000 in total) Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 7 A Possible Outcome (Table 2.1, page 30) Da y Trade Price ($) 1 1,450.0 0 Settle Price ($) Daily Gain ($) Cumul. Gain ($) Margin Balance ($) 12,000 1 1,441.0 0 −1,800 − 1,800 10,200 2 1,438.3 0 −540 −2,340 9,660 ….. ….. ….. 6 1,436.2 0 −780 −2,760 9,240 7 1,429.9 0 −1,260 −4,020 7,980 ….. 8 Margin Call ($) …… 1,430.8 −3,8409th Edition, 12,180 Options, Futures, and 180 Other Derivatives, 0 Copyright © John C. Hull 2014 4,020 8 Margin Cash Flows When Futures Price Increases Clearing House Clearing House Member Clearing House Member Broker Broker Long Trader Short Trader Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 9 Margin Cash Flows When Futures Price Decreases Clearing House Clearing House Member Clearing House Member Broker Broker Long Trader Short Trader Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 10 Some Terminology Open interest: the total number of contracts outstanding equal to number of long positions or number of short positions Settlement price: the price just before the final bell each day used for the daily settlement process Volume of trading: the number of trades in one day Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 11 Key Points About Futures They are settled daily Closing out a futures position involves entering into an offsetting trade Most contracts are closed out before maturity Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 12 Crude Oil Trading on May 14, 2013 (Table 2.2, page 36) Open High Low Prior Settl e Last Trade Change Volume Jun 2013 94.93 95.6 6 94.50 95.17 94.72 −0.45 162,901 Aug 2013 95.24 95.9 2 94.81 95.43 95.01 −0.42 37,830 Dec 2013 93.77 94.3 7 93.39 93.89 93.60 −0.29 27,179 Dec 2014 89.98 90.0 9 89.40 89.71 89.62 −0.09 9,606 Dec 2015 86.99 87.3 3 86.94 86.99 86.94 −0.05 2,181 Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 13 Collateralization in OTC Markets It is becoming increasingly common for transactions to be collateralized in OTC markets Consider transactions between companies A and B These might be governed by an ISDA Master agreement with a credit support annex (CSA) The CSA might require A to post collateral with B equal to the value to B of its outstanding transactions with B when this value is positive. Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 14 Collateralization in OTC Markets continued If A defaults, B is entitled to take possession of the collateral The transactions are not settled daily and interest is paid on cash collateral See Business Snapshot 2.2 for how collateralization affected Long Term Capital Management when there was a “flight to quality” in 1998. Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 15 Clearing Houses and OTC Markets Traditionally most transactions have been cleared bilaterally in OTC markets Following the 2007-2009 crisis, the has been a requirement for most standardized OTC derivatives transactions between dealers to be cleared through central counterparties (CCPs) CCPs require initial margin, variation margin, and default fund contributions from members similarly to exchange clearing houses Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 16 Bilateral Clearing vs Central Clearing House Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 17 New Regulations New regulations for trades between dealers that are not cleared centrally require dealers to post both initial margin and daily variation margin The initial margin is posted with a third party Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 18 Delivery If a futures contract is not closed out before maturity, it is usually settled by delivering the assets underlying the contract. When there are alternatives about what is delivered, where it is delivered, and when it is delivered, the party with the short position chooses. A few contracts (for example, those on stock indices and Eurodollars) are settled in cash Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 19 Questions When a new trade is completed what are the possible effects on the open interest? in two ways: 1) Increase open interest 2) Decrease open interest Can the volume of trading in a day be greater than the open interest? Yes, it indicates that many traders who entered into a positions during the day closed them out before the end of the day (day traders) 20 Types of Orders Limit Stop-loss Stop-limit Market-if touched Discretionary Time of day Open Fill or kill Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 21 Regulation of Futures In the US, the regulation of futures markets is primarily the responsibility of the Commodity Futures and Trading Commission (CFTC) Regulators try to protect the public interest and prevent questionable trading practices Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 22 Accounting & Tax Ideally hedging profits (losses) should be recognized at the same time as the losses (profits) on the item being hedged Ideally profits and losses from speculation should be recognized on a mark-to-market basis Roughly speaking, this is what the accounting and tax treatment of futures in the U.S. and many other countries attempt to achieve Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 23 Forward Contracts vs Futures Contracts (Table 2.3, page 43) FORWARDS FUTURES Private contract between 2 parties Exchange traded Non-standard contract Standard contract Usually 1 specified delivery date Range of delivery dates Settled at end of contract Delivery or final cash settlement usually occurs Some credit risk Settled daily Contract usually closed out prior to maturity Virtually no credit risk Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 24 Foreign Exchange Quotes Futures exchange rates are quoted as the number of USD per unit of the foreign currency Forward exchange rates are quoted in the same way as spot exchange rates. This means that GBP, EUR, AUD, and NZD are quoted as USD per unit of foreign currency. Other currencies (e.g., CAD and JPY) are quoted as units of the foreign currency per USD. Options, Futures, and Other Derivatives, 9th Edition, Copyright © John C. Hull 2014 25
