A FUTURES CONTRACT is a legal contract in the US under the Commodities Exchange Act of 1850. The futures contract allow market participants to take or make delivery of a commodity on some date in the future at a price agreed to today. In many cases businesses plan their raw supply needs and/or their production ahead of time. Often businesses can make contracts between each other, but the benefits offered by the futures markets centralized trading standard contract terms and the risk mitigation of the Clearinghouse made futures well in demand as our country grew. By having a central marketplace (electronic bulletin board) where buyer and seller can meet and transact also begets liquidity. Then, the investment Managers will tend to get interested in a products along with the speculator & arbitrageur. Futures are OBLIGATIONS. Both buyer and seller are obligated to perform to the terms of their contract. Futures contracts are standardized with respect to all terms and conditions:
|Symbol:||CL_7 <comdty> P [go] (for the price of the __month* (7=2017) on Bloomberg|
|Quantity:||1,000 barrels of WTI Crude Oil|
|Quality:||WTI describes the area in West Texas where the crude oil a very light & very sweet|
|Delivery Point:||Cushing, Oklahoma|
|Contract Value||WTI trading @ $50 per barrel * 1,000 barrels = $50,000 CONTRACT VALUE WTI trading @ $51 per barrel * 1,000 barrels = $51,000 CONTRACT VALUE CHANGE IN CONTRACT VALUE FROM $50 TO $51 = $1,000|
|Execution||Futures contracts trade on an “exchange”, electronic or telephone. Futures Options still trade on exchange floors due to the complexity of order types.|
|Clearing||All Futures contracts are cleared at a Clearinghouse In the US futures exchanges had their own clearinghouses. Each futures contract traded and cleared on the same exchange. As trading moved to electronic market and a wider range of types of crude oil’s trading, Clearinghouses for each product are not as connected to the execution location.|
Clearinghouses are Organization of Mutuality that is the risk belongs to the owners of the Clearinghouse. If a client defaults on a trade, i.e., cannot post more margin, the introducing broker has a choice: they can cover the loss themselves, or if they’re unable to afford the loss they can bring it to the clearinghouse committee. Each member will share in the loss on a pro-rata basis.
As mentioned above, futures contracts clear at a clearinghouse. Long & Short both post INTIAL MARGIN or a good faith deposit. Thereafter the positions are marked to the market: the counterparty making money receives more margin. The counterparty losing money pays more margin. This additional margin is called variation margin. Initial Margin acts as a cushion and variation margin allows for the settlement of P&L daily. This system allows clearinghouses to mitigate the counterparty risk. Here is a list of futures contracts with specifications and margin
Initial Margin = $3,190 Both long and short post $3,190 for each contract they want to keep open overnight. While they may choose to get out of the trade when Asia or Europe are trading, they will have to post $3,190 to their US-based clearinghouse. Variation or Maintenance Margin = $2,900 Maintenance margin is a trigger. The client will be called for additional margin if the account falls below the maintenance level. During the credit crisis, Maintenance Margin wasn’t used and some firms have chosen to maintain that policy. Herefore a client must always have the initial margin for the contract set aside in a segregated account as a good-faith or performance bond. Check with your broker prior to trading so you know their specific guidelines.
Using the Futures Margin Example above, FOCUS ON THE TWO RIGHT MOST COLUMNS TO SEE HOW Volume & Open Interest Work. Volume and open interest are specific to contract markets. But by measuring the volume relative to the open interest a trader can glean a lot of clues as to:
Volume: Contracts traded during the trading day. Volume is additive throughout the day. Open Interest: Open Contracts held in position. Open Interest measures the net OPEN contracts. If a market has very high daily volume, but open interest remains stable, one could surmise that market has more speculators involved in that market. By contrast, a futures market with high volume sporadically but where open interest grows on those days and progressively over the life of the contract, one could surmise that market has more hedgers involved than speculators.