A Note On Currency And Index Futures
 INTRODUCTION:Futures trading started way back
in 1865 on the Chicago Board of Trade (CBOT), but prior to 1972, the
underlying asset of futures contracts were agricultural commodities. The
futures market met the needs of farmers and merchants. It overcame a few of
the drawbacks related to the forwards market[1] (Refer Exhibit I) like
non-standardization of contract and credit risk.
Trading in financial futures started only after the World War II on the two
largest exchanges i.e. the CBOT and the Chicago Mercantile Exchange (CME).
Post-1972, there was further development of futures contracts, with the
introduction of a range of financial instruments. However, it was only in
1994, that these financial products started to be traded electronically.
DEFINING THE TERMS:
A futures contract is an agreement between two parties to buy or sell an
asset at a certain time in the future at a certain price. The underlying
asset of a futures contract may be an agricultural commodity (such as
corn, wheat, soybean, or soybean oils), or a financial instrument (such
as treasury bonds, treasury notes and shares). Unlike forward contracts
[2], futures contracts are standardized (in terms of contract size,
expiration month, trading cycle, etc.) and are traded in an organized
exchange.
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In referring to futures contracts, there are number of other terms that
are commonly used. Spot price is the price at which an asset trades in
the spot market[3] .
The price at which the futures contract trades in the
futures market is called the futures price (Refer Exhibit II). A contract
cycle is the period over which a contract trades. An investor can take two
positions in a futures contract, a ‘long futures position'or a ‘short
futures position.'The investor is said to have taken a long position when
he/she is buying, and is said to have taken a short position when he/she is
selling, a futures contract. Expiry date is the last day on which the
contract is traded at the end of which it will cease to exist. The amount of
the asset that has to be delivered under a contract is known as the contract
size. The difference between two futures prices is known as spread. The
difference between two futures prices for the same underlying commodity on
two different expiration dates is known as ‘intra commodity'spread. The
difference between two futures prices for two different but related
commodities is known as ‘inter commodity'spread. The price difference
between the two markets for the same commodity is known as ‘inter market'spread.
In the context of financial asset futures, basis is defined as the futures
price minus the spot price. In a normal market[4] , the basis is positive,
reflecting the fact that futures prices normally exceed spot prices.
However, in case, the futures prices are less than the spot prices, the
difference is known as backwardation. Another definition of basis is the
difference between spot price of the asset to be hedged and the futures
price of the contract of that asset. Cost of carry shows the relationship
between future prices and spot prices. It measures the storage cost plus the
interest paid minus the income earned.
The members who execute the trades on the exchange floor are floor brokers
and floor traders. The brokers who execute the order on others'account are
known as floor brokers. They act according to the wishes of their customers
and are basically agents for public investors. Floor traders execute trades
exclusively on their own account. Those floor traders who also execute
trades on others account are known as dual traders, and the mechanism is
known as dual trading. In the market, some of the floor traders are known as
scalpers. They are the individuals who trade on their own account and stand
ready either to buy or sell. They are also called as locals and by their
active participation provide liquidity to the futures market.
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CLEARING HOUSE
FIGURE I
TYPES OF MARGIN:
SETTLEMENT PROCEDURES
APPLICATIONS OF FUTURES
TYPES OF FUTURES
TRADING USING CURRENCY FUTURES
TRADING USING INDEX FUTURES
CONCLUSION
EXHIBIT I DIFFERENCE BETWEEN FUTURES AND FORWARDS CONTRACTS
EXHIBIT II A NOTE ON ANALYZING FUTURES PRICES
ADDITIONAL READINGS AND REFERENCES
[1] A forward market does not have any fixed location
and are self regulated.
[2] Two parties sign this type of deferred contract where they agree to buy
and sell an asset at some point of time in future under mutually acceptable
terms and conditions.
[3] Any market in which cash is exchanged for current delivery of an asset.
[4] The futures market can portray a pattern of either a normal market or an
inverted market. If the prices of the distant futures are higher than the
near futures, it is referred to as the normal market condition.
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