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| In [[finance]], a '''futures contract''' (more colloquially, '''futures''') is a standardized [[contract]] between two parties to buy or sell a specified asset of standardized quantity and quality for a price agreed upon today (the ''futures price'' or [[strike price]]) with delivery and payment occurring at a specified future date, the ''delivery date''. The contracts are negotiated at a [[futures exchange]], which acts as an intermediary between the two parties. The party agreeing to buy the underlying asset in the future, the "buyer" of the contract, is said to be "[[Long (finance)|long]]", and the party agreeing to sell the asset in the future, the "seller" of the contract, is said to be "[[Short (finance)|short]]".
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| While the futures contract specifies a trade taking place in the future, the purpose of the futures exchange institution is to act as intermediary and minimize the risk of default by either party. Thus the exchange requires both parties to put up an initial amount of cash (performance bond), the [[Futures contract#Margin|margin]]. Additionally, since the futures price will generally change daily, the difference in the prior agreed-upon price and the daily futures price is settled daily also (variation margin). The exchange will draw money out of one party's margin account and put it into the other's so that each party has the appropriate daily loss or profit. If the margin account goes below a certain value, then a margin call is made and the account owner must replenish the margin account. This process is known as ''marking to market''. Thus on the delivery date, the amount exchanged is not the specified price on the contract but the [[spot price|spot value]] (i.e. the original value agreed upon, since any gain or loss has already been previously settled by marking to market).
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| A closely related contract is a [[forward contract]]. A forward is like a futures in that it specifies the exchange of goods for a specified price at a specified future date. However, a forward is not traded on an exchange and thus does not have the interim partial payments due to marking to market. Nor is the contract standardized, as on the exchange.
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| Unlike an [[option (finance)|option]], both parties of a futures contract must fulfill the contract on the delivery date. The seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures contract, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures [[position (finance)|position]] can close out its contract obligations by taking the opposite position on another futures contract on the same asset and settlement date. The difference in futures prices is then a profit or loss.
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| ==Origin==
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| The first futures exchange market was the [[Dōjima Rice Exchange]] in Japan in the 1730s, to meet the needs of [[samurai]] who—being paid in rice, and after a series of bad harvests—needed a stable conversion to coin.<ref>
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| {{Cite journal
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| | doi=10.1016/0378-4266(89)90028-9
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| | last=Schaede
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| | first=Ulrike
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| | authorlink = Ulrike Schaede
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| | title=Forwards and futures in tokugawa-period Japan:A new perspective on the Djima rice market
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| | journal=Journal of Banking & Finance
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| | volume=13
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| | issue=4–5
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| |date=September 1989
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| | pages=487–513
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| | postscript=<!-- Bot inserted parameter. Either remove it; or change its value to "." for the cite to end in a ".", as necessary. --> | |
| }}</ref>
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| The [[Chicago Board of Trade]] (CBOT) listed the first ever standardized 'exchange traded' forward contracts in 1864, which were called futures contracts. This contract was based on [[grain]] trading and started a trend that saw contracts created on a number of different [[Commodity|commodities]] as well as a number of futures exchanges set up in countries around the world.<ref name="timeline-of-achievements">{{cite web |url=http://www.cmegroup.com/company/history/timeline-of-achievements.html |title=timeline-of-achievements |publisher=[[CME Group]] |accessdate=August 5, 2010 }}</ref> By 1875 cotton futures were being traded in [[Mumbai]] in India and within a few years this had expanded to futures on [[Vegetable fats and oils|edible oilseeds complex]], raw [[jute]] and jute goods and [[bullion]].<ref name="Inter-Ministerial task force chaired by Wajahat Habibullah">{{cite web |url=http://www.fmc.gov.in/htmldocs/reports/rep03.htm |title=Convergence of Securities and Commodity Markets report |author=Inter-Ministerial task force (chaired by Wajahat Habibullah) |publisher=[[Forward Markets Commission (India)]] |date=May 2003 |accessdate=August 5, 2010 }}</ref>
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| ==Margin==
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| {{Main|Margin (finance)}}
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| [[File:Futures Trading Composition.jpg|right|260px|美國期貨變遷]]
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| To minimize [[credit risk]] to the exchange, traders must post a [[Margin (finance)|margin]] or a [[performance bond]], typically 5%-15% of the contract's value.
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| To minimize [[counterparty risk]] to traders, trades executed on regulated futures exchanges are guaranteed by a clearing house. The clearing house becomes the buyer to each seller, and the seller to each Buyer, so that in the event of a counterparty default the clearer assumes the risk of loss. This enables traders to transact without performing [[due diligence]] on their counterparty.
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| Margin requirements are waived or reduced in some cases for [[Hedge (finance)|hedgers]] who have physical ownership of the covered [[commodity]] or [[spread trader]]s who have offsetting contracts balancing the position.
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| '''Clearing margin''' are financial safeguards to ensure that companies or corporations perform on their customers' open futures and options contracts. Clearing margins are distinct from customer margins that individual buyers and sellers of futures and options contracts are required to deposit with brokers.
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| '''Customer margin''' Within the futures industry, financial guarantees required of both buyers and sellers of futures contracts and sellers of options contracts to ensure fulfillment of contract obligations. [[Futures Commission Merchants]] are responsible for overseeing customer margin accounts. Margins are determined on the basis of market risk and contract value. Also referred to as performance bond margin.
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| '''Initial margin''' is the equity required to initiate a futures position. This is a type of performance bond. The maximum exposure is not limited to the amount of the initial margin, however the initial margin requirement is calculated based on the maximum estimated change in contract value within a trading day. Initial margin is set by the exchange.
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| If a position involves an exchange-traded product, the amount or percentage of initial margin is set by the exchange concerned.
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| In case of loss or if the value of the initial margin is being eroded, the broker will make a margin call in order to restore the amount of initial margin available. Often referred to as “variation margin”, margin called for this reason is usually done on a daily basis, however, in times of high volatility a broker can make a margin call or calls intra-day.
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| Calls for margin are usually expected to be paid and received on the same day. If not, the broker has the right to close sufficient positions to meet the amount called by way of margin. After the position is closed-out the client is liable for any resulting deficit in the client’s account.
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| Some U.S. exchanges also use the term “maintenance margin”, which in effect defines by how much the value of the initial margin can reduce before a margin call is made. However, most non-US brokers only use the term “initial margin” and “variation margin”.
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| The Initial Margin requirement is established by the Futures exchange, in contrast to other securities' Initial Margin (which is set by the Federal Reserve in the U.S. Markets).
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| A futures account is marked to market daily. If the margin drops below the margin maintenance requirement established by the exchange listing the futures, a margin call will be issued to bring the account back up to the required level.
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| '''Maintenance margin''' A set minimum margin per outstanding futures contract that a customer must maintain in their margin account.
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| '''Margin-equity ratio''' is a term used by [[speculator]]s, representing the amount of their trading capital that is being held as margin at any particular time. The low margin requirements of futures results in substantial leverage of the investment. However, the exchanges require a minimum amount that varies depending on the contract and the trader. The broker may set the requirement higher, but may not set it lower. A trader, of course, can set it above that, if he does not want to be subject to margin calls.
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| '''Performance bond margin''' The amount of money deposited by both a buyer and seller of a futures contract or an options seller to ensure performance of the term of the contract. Margin in commodities is not a payment of equity or down payment on the commodity itself, but rather it is a security deposit.
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| '''Return on margin''' (ROM) is often used to judge performance because it represents the gain or loss compared to the exchange’s perceived risk as reflected in required margin. ROM may be calculated (realized return) / (initial margin). The Annualized ROM is equal to (ROM+1)<sup>(year/trade_duration)</sup>-1. For example if a trader earns 10% on margin in two months, that would be about 77% annualized.
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| ==Settlement - physical versus cash-settled futures==
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| Settlement is the act of [[wikt:consummating|consummating]] the contract, and can be done in one of two ways, as specified per type of futures contract:
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| * '''Physical delivery''' - the amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. Physical delivery is common with commodities and bonds. In practice, it occurs only on a minority of contracts. Most are cancelled out by purchasing a covering position - that is, buying a contract to cancel out an earlier sale (covering a short), or selling a contract to liquidate an earlier purchase (covering a long). The Nymex crude futures contract uses this method of settlement upon expiration
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| * '''[[Cash settlement]]''' - a cash payment is made based on the underlying [[reference rate]], such as a short term interest rate index such as [[91 Days T-Bills]], or the closing value of a [[stock market index]]. The parties settle by paying/receiving the loss/gain related to the contract in cash when the contract expires.<ref>[[Wikinvest:Cash settlement|Cash settlement on Wikinvest]]</ref> Cash settled futures are those that, as a practical matter, could not be settled by delivery of the referenced item - i.e. how would one deliver an index? A futures contract might also opt to settle against an index based on trade in a related spot market. ICE Brent futures use this method.
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| '''Expiry''' (or '''Expiration''' in the U.S.) is the time and the day that a particular delivery month of a futures contract stops trading, as well as the final settlement price for that contract. For many equity index and interest rate futures contracts (as well as for most equity options), this happens on the third Friday of certain trading months. On this day the ''t+1'' futures contract becomes the ''t'' futures contract. For example, for most [[Chicago Mercantile Exchange|CME]] and [[Chicago Board of Trade|CBOT]] contracts, at the expiration of the December contract, the March futures become the nearest contract. This is an exciting time for arbitrage desks, which try to make quick profits during the short period (perhaps 30 minutes) during which the [[underlying]] cash price and the futures price sometimes struggle to converge. At this moment the futures and the underlying assets are extremely liquid and any disparity between an index and an underlying asset is quickly traded by arbitrageurs. At this moment also, the increase in volume is caused by traders rolling over positions to the next contract or, in the case of equity index futures, purchasing underlying components of those indexes to hedge against current index positions. On the expiry date, a European equity arbitrage trading desk in London or Frankfurt will see positions expire in as many as eight major markets almost every half an hour.
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| ==Pricing==
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| When the deliverable asset exists in plentiful supply, or may be freely created, then the price of a futures contract is determined via [[arbitrage]] arguments. This is typical for [[Stock market index future|stock index futures]], [[Interest rate future|treasury bond futures]], and [[Commodity futures|futures on physical commodities]] when they are in supply (e.g. agricultural crops after the harvest). However, when the deliverable commodity is not in plentiful supply or when it does not yet exist - for example on crops before the harvest or on [[Eurodollar]] Futures or [[Federal funds rate]] futures (in which the supposed underlying instrument is to be created upon the delivery date) - the futures price cannot be fixed by arbitrage. In this scenario there is only one force setting the price, which is simple [[supply and demand]] for the asset in the future, as expressed by supply and demand for the futures contract.
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| ===Arbitrage arguments===
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| Arbitrage arguments ("[[Rational pricing]]") apply when the deliverable asset exists in plentiful supply, or may be freely created. Here, the forward price represents the expected future value of the underlying [[discounting|discounted]] at the [[risk-free interest rate|risk free rate]]—as any deviation from the theoretical price will afford investors a riskless profit opportunity and should be arbitraged away. We define the forward price to be the strike K such that the contract has 0 value at the present time. Assuming interest rates are constant the forward price of the future is equal to the forward price of the forward contract with the same strike and maturity. It is also the same if the underlying asset is uncorrelated with interest rates. Otherwise the difference between the forward price on the future (futures price) and forward price on the asset, is proportional to the covariance between the underlying asset price and interest rates. For example, a future on a zero coupon bond will have a futures price lower than the forward price. This is called the futures "convexity correction."
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| Thus, assuming constant rates, for a simple, non-dividend paying asset, the value of the future/forward price, ''F(t,T)'', will be found by compounding the present value ''S(t)'' at time ''t'' to maturity ''T'' by the rate of risk-free return ''r''.
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| :<math>F(t,T) = S(t)\times (1+r)^{(T-t)}</math>
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| or, with ''[[Compound interest#Continuous compounding|continuous compounding]]''
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| :<math>F(t,T) = S(t)e^{r(T-t)} \,</math>
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| This relationship may be modified for storage costs, dividends, dividend yields, and convenience yields.
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| In a perfect market the relationship between futures and spot prices depends only on the above variables; in practice there are various market imperfections (transaction costs, differential borrowing and lending rates, restrictions on short selling) that prevent complete arbitrage. Thus, the futures price in fact varies within arbitrage boundaries around the theoretical price.
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| ===Pricing via expectation===
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| When the deliverable commodity is not in plentiful supply (or when it does not yet exist) rational pricing cannot be applied, as the arbitrage mechanism is not applicable. Here the price of the futures is determined by today's [[supply and demand]] for the underlying asset in the futures.
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| In a deep and liquid market, supply and demand would be expected to balance out at a price which represents an [[Expected value#Uses and applications|unbiased expectation]] of the future price of the actual asset and so be given by the simple relationship.
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| :<math>F(t) = E_t\left\{S(T)\right\} </math>
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| By contrast, in a shallow and illiquid market, or in a market in which large quantities of the deliverable asset have been deliberately withheld from market participants (an illegal action known as [[cornering the market]]), the market clearing price for the futures may still represent the balance between supply and demand but the relationship between this price and the expected future price of the asset can break down.
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| ===Relationship between arbitrage arguments and expectation===
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| The expectation based relationship will also hold in a no-arbitrage setting when we take expectations with respect to the [[risk-neutral probability]]. In other words: a futures price is [[Martingale (probability theory)|martingale]] with respect to the risk-neutral probability. With this pricing rule, a speculator is expected to break even when the futures market fairly prices the deliverable commodity.
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| ===Contango and backwardation===
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| The situation where the price of a commodity for future delivery is higher than the [[spot price]], or where a far future delivery price is higher than a nearer future delivery, is known as [[contango]]. The reverse, where the price of a commodity for future delivery is lower than the spot price, or where a far future delivery price is lower than a nearer future delivery, is known as [[backwardation]].
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| ==Futures contracts and exchanges==
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| '''Contracts'''
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| There are many different kinds of futures contracts, reflecting the many different kinds of "tradable" assets about which the contract may be based such as commodities, securities (such as [[single-stock futures]]), currencies or intangibles such as interest rates and indexes. For information on futures markets in specific underlying [[commodity markets]], follow the links. For a list of tradable commodities futures contracts, see [[List of traded commodities]]. See also the [[futures exchange]] article.
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| * [[Foreign exchange market]]
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| * [[Money market]]
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| * [[Bond market]]
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| * [[Equity derivative#Equity futures, options and swaps|Equity market]]
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| * [[Soft Commodities market]]
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| Trading on [[commodity|commodities]] began in Japan in the 18th century with the trading of rice and silk, and similarly in Holland with tulip bulbs. Trading in the US began in the mid 19th century, when central grain markets were established and a marketplace was created for farmers to bring their commodities and sell them either for immediate delivery (also called spot or cash market) or for forward delivery. These forward contracts were private contracts between buyers and sellers and became the forerunner to today's exchange-traded futures contracts. Although contract trading began with traditional commodities such as grains, meat and livestock, exchange trading has expanded to include metals, energy, currency and currency indexes, equities and equity indexes, government interest rates and private interest rates.
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| '''Exchanges'''
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| Contracts on financial instruments were introduced in the 1970s by the [[Chicago Mercantile Exchange]] (CME) and these instruments became hugely successful and quickly overtook commodities futures in terms of trading volume and global accessibility to the markets. This innovation led to the introduction of many new futures exchanges worldwide, such as the [[London International Financial Futures and Options Exchange|London International Financial Futures Exchange]] in 1982 (now [[Euronext.liffe]]), Deutsche Terminbörse (now [[Eurex]]) and the [[Tokyo Commodity Exchange]] (TOCOM). Today, there are more than 90 futures and futures options exchanges worldwide trading to include:
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| * [[CME Group]] (formerly CBOT and CME) -- Currencies, Various Interest Rate derivatives (including US Bonds); Agricultural (Corn, Soybeans, Soy Products, Wheat, Pork, Cattle, Butter, Milk); Index (Dow Jones Industrial Average); Metals (Gold, Silver), Index (NASDAQ, S&P, etc.)
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| * [[IntercontinentalExchange]] (ICE Futures Europe) - formerly the [[International Petroleum Exchange]] trades energy including [[crude oil]], heating oil, gas oil (diesel), refined petroleum products, electric power, coal, [[natural gas]], and emissions
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| * [[NYSE Euronext]] - which absorbed [[Euronext]] into which [[London International Financial Futures and Options Exchange]] or [[LIFFE]] (pronounced 'LIFE') was merged. (LIFFE had taken over London Commodities Exchange ("LCE") in 1996)- softs: grains and meats. Inactive market in [[Baltic Exchange]] shipping. Index futures include [[EURIBOR]], [[FTSE 100]], [[CAC 40]], [[AEX index]].
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| * [[South African Futures Exchange - SAFEX]]
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| * [[Sydney Futures Exchange]]
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| * [[Tokyo Stock Exchange]] TSE (JGB Futures, TOPIX Futures)
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| * [[Tokyo Commodity Exchange]] TOCOM
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| * [http://www.tfx.co.jp/en/ Tokyo Financial Exchange] - TFX - (Euroyen Futures, OverNight CallRate Futures, SpotNext RepoRate Futures)
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| * [[Osaka Securities Exchange]] OSE (Nikkei Futures, RNP Futures)
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| * [[London Metal Exchange]] - metals: [[copper]], [[aluminium]], [[lead]], [[zinc]], [[nickel]], [[tin]] and steel
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| * [[IntercontinentalExchange]] (ICE Futures U.S.) - formerly New York Board of Trade - softs: [[Cocoa bean|cocoa]], [[coffee]], [[cotton]], [[orange juice]], [[sugar]]
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| * [[New York Mercantile Exchange]] CME Group- energy and metals: [[crude oil]], [[gasoline]], [[heating oil]], [[natural gas]], [[coal]], [[propane]], [[Gold as an investment|gold]], [[Silver as an investment|silver]], [[Platinum as an investment|platinum]], [[copper]], [[aluminum]] and [[Palladium as an investment|palladium]]
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| * [[Dubai Mercantile Exchange]]
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| * [[Korea Exchange]] - KRX
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| * [[Singapore Exchange]] - SGX - into which merged [[Singapore International Monetary Exchange]] (SIMEX)
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| * [[ROFEX]] - Rosario (Argentina) Futures Exchange
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| * [[NCDEX]] - National Commodity and Derivatives Exchange, India
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| ===Codes===
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| Most Futures contracts codes are five characters. The first two characters identify the contract type, the third character identifies the month and the last two characters identify the year.
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| Third (month) futures contract codes are
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| * January = F
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| * February = G
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| * March = H
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| * April = J
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| * May = K
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| * June = M
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| * July = N
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| * August = Q
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| * September = U
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| * October = V
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| * November = X
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| * December = Z
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| Example: CLX14 is a Crude Oil (CL), November (X) 2014 (14) contract.<ref>http://www.cmegroup.com/product-codes-listing/month-codes.html</ref>
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| ==Who trades futures?==
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| Futures traders are traditionally placed in one of two groups: [[Hedge (finance)|hedgers]], who have an interest in the underlying asset (which could include an intangible such as an index or interest rate) and are seeking to ''hedge out'' the risk of price changes; and [[speculator]]s, who seek to make a profit by predicting market moves and opening a [[derivative (finance)|derivative]] contract related to the asset "on paper", while they have no practical use for or intent to actually take or make delivery of the underlying asset. In other words, the investor is seeking exposure to the asset in a long futures or the opposite effect via a short futures contract.
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| ===Hedgers===
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| Hedgers typically include producers and [[consumer]]s of a commodity or the owner of an asset or assets subject to certain influences such as an interest rate.
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| For example, in traditional [[commodity market]]s, [[farmer]]s often sell futures contracts for the crops and livestock they produce to guarantee a certain price, making it easier for them to plan. Similarly, livestock producers often purchase futures to cover their feed costs, so that they can plan on a fixed cost for feed. In modern (financial) markets, "producers" of [[interest rate swaps]] or [[equity derivative]] products will use financial futures or equity index futures to reduce or remove the risk on the [[swap (finance)|swap]].
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| Those that buy or sell commodity futures need to be careful. If a company buys contracts hedging against price increases, but in fact the market price of the commodity is substantially lower at time of delivery, they could find themselves disastrously non-competitive (for example see: [[VeraSun Energy]]).
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| ===Speculators===
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| Speculators typically fall into three categories: position traders, [[day traders]], and swing traders ([[swing trading]]), though many hybrid types and unique styles exist. With many investors pouring into the futures markets in recent years controversy has risen about whether speculators are responsible for increased volatility in commodities like oil, and experts are divided on the matter.
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| <ref>Dreibus, Tony C. [http://www.bloomberg.com/news/2011-06-05/commodity-bubbles-caused-by-speculators-need-intervention-un-agency-says.html Commodity Bubbles Caused by Speculators Need Intervention, UN Agency Says], ''Bloomberg'', June 5, 2011. Accessed July 2, 2011</ref>
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| An example that has both hedge and speculative notions involves a [[mutual fund]] or [[separately managed account]] whose investment objective is to track the performance of a stock index such as the S&P 500 stock index. The [[Portfolio manager]] often "equitizes" cash inflows in an easy and cost effective manner by investing in (opening long) S&P 500 stock index futures. This gains the portfolio exposure to the index which is consistent with the fund or account investment objective without having to buy an appropriate proportion of each of the individual 500 stocks just yet. This also preserves balanced diversification, maintains a higher degree of the percent of assets invested in the market and helps reduce [[tracking error]] in the performance of the fund/account. When it is economically feasible (an efficient amount of shares of every individual position within the fund or account can be purchased), the portfolio manager can close the contract and make purchases of each individual stock.
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| The social utility of futures markets is considered to be mainly in the transfer of [[risk]], and increased liquidity between traders with different risk and [[time preference]]s, from a hedger to a speculator, for example.{{Citation needed|date=June 2013}}
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| ==Options on futures==
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| <!-- This section is linked from [[Put option]] -->
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| In many cases, ''[[Option (finance)|options]]'' are traded on futures, sometimes called simply "futures options". A [[put option|put]] is the option to sell a futures contract, and a [[call option|call]] is the option to buy a futures contract. For both, the option [[strike price]] is the specified futures price at which the future is traded if the option is exercised. Futures are often used since they are [[Delta One|delta one]] instruments. Calls and options on futures may be priced similarly to those on traded assets by using an extension of the [[Black-Scholes formula]], namely the [[Black–Scholes]] model for futures.
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| Investors can either take on the role of option seller/option writer or the option buyer. Option sellers are generally seen as taking on more risk because they are contractually obligated to take the opposite futures position if the options buyer exercises their right to the futures position specified in the option. The price of an option is determined by supply and demand principles and consists of the option premium, or the price paid to the option seller for offering the option and taking on risk.<ref name="CME">{{cite web|author=[[CME Group]]|url=http://www.cmegroup.com/resources-for/files/G66_Options_on_Fut2001.pdf|title=CME Options on Futures: The Basics|accessdate={{date|February 8, 2011}}}}</ref>
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| ==Futures contract regulations==
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| All futures transactions in the [[United States]] are regulated by the [[Commodity Futures Trading Commission]] (CFTC), an [[Independent agencies of the United States government|independent agency of the United States government]]. The Commission has the right to hand out [[Fine (penalty)|fines]] and other punishments for an individual or company who breaks any rules. Although by [[law]] the commission regulates all transactions, each exchange can have its own rule, and under contract can fine companies for different things or extend the fine that the CFTC hands out.
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| The CFTC publishes weekly reports containing details of the [[open interest]] of market participants for each market-segment that has more than 20 participants. These reports are released every Friday (including data from the previous Tuesday) and contain data on open interest split by reportable and non-reportable open interest as well as commercial and non-commercial open interest. This type of report is referred to as the '[[Commitments of Traders|Commitments of Traders Report]]', COT-Report or simply COTR.
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| ==Definition of futures contract==
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| Following Björk<ref>Björk: Arbitrage theory in continuous time, Cambridge university press, 2004</ref> we give a definition of a ''futures contract''. We describe a futures contract with delivery of item J at the time T:
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| * There exists in the market a quoted price ''F(t,T)'', which is known as the futures price at time t for delivery of J at time T.
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| * The price of entering a futures contract is equal to zero.
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| * During any time interval <math> [t,s] </math>, the holder receives the amount <math> F(s,T) - F(t,T) </math>. (this reflects instantaneous marking to market)
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| * At time ''T'', the holder pays ''F(T,T)'' and is entitled to receive J. Note that ''F(T,T)'' should be the spot price of J at time T.
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| ==Nonconvergence==
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| {{Original research|section|date=April 2008}}
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| Some exchanges tolerate 'nonconvergence', the failure of futures contracts and the value of the physical commodities they represent to reach the same value on 'contract settlement' day at the designated delivery points. An example of this is the CBOT (Chicago Board of Trade) Soft Red Winter wheat (SRW) futures. SRW futures have settled more than 20¢ apart on settlement day and as much as $1.00 difference between settlement days. Only a few participants holding CBOT SRW futures contracts are qualified by the CBOT to make or receive delivery of commodities to settle futures contracts. Therefore, it's impossible for almost any individual producer to 'hedge' efficiently when relying on the final settlement of a futures contract for SRW. The trend is for the CBOT to continue to restrict those entities that can actually participate in settling commodities contracts to those that can ship or receive large quantities of railroad cars and multiple barges at a few selected sites. The [[Commodity Futures Trading Commission]], which has oversight of the futures market in the United States, has made no comment as to why this trend is allowed to continue since economic theory and CBOT publications maintain that convergence of contracts with the price of the underlying commodity they represent is the basis of integrity for a futures market.
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| It follows that the function of [[price discovery]], the ability of the markets to discern the appropriate value of a commodity reflecting current conditions, is degraded in relation to the discrepancy in price and the inability of producers to enforce contracts with the commodities they represent.<ref>Henriques, D [http://www.iht.com/articles/2008/03/27/business/commod.php Mysterious discrepancies in grain prices baffle experts], ''International Herald Tribune'', March 23, 2008. Accessed April 12, 2008</ref>
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| ==Futures versus forwards==
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| While futures and [[forward contract]]s are both contracts to deliver an asset on a future date at a prearranged price, they are different in two main respects:
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| * Futures are '''[[Futures exchange|exchange-traded]],''' while forwards are traded '''[[over-the-counter (finance)|over-the-counter]].'''
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| *: Thus futures are '''standardized''' and face an '''exchange,''' while forwards are '''customized''' and face a non-exchange '''counterparty.'''
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| * Futures are [[#Margin|margined]], while forwards are not.
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| *: Thus futures have significantly less '''[[credit risk]],''' and have different funding.
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| The [[Futures Industry Association]] (FIA) estimates that 6.97 billion futures contracts were traded in 2007, an increase of nearly 32% over the 2006 figure.
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| ===Exchange versus OTC===
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| Futures are always traded on an [[Futures exchange|exchange]], whereas forwards always trade [[over-the-counter (finance)|over-the-counter]], or can simply be a signed contract between two parties.
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| Thus:
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| * Futures are highly standardized, being exchange-traded, whereas forwards can be unique, being over-the-counter.
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| * In the case of physical delivery, the forward contract specifies to whom to make the delivery. The counterparty for delivery on a futures contract is chosen by the [[Clearing house (finance)|clearing house]].
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| ===Margining===
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| {{details|Margin (finance)|Margin}}
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| Futures are [[#Margin|margined]] daily to the daily [[spot price]] of a forward with the same agreed-upon delivery price and underlying asset (based on ''[[mark to market]]'').
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| Forwards do not have a standard. They may transact only on the settlement date. More typical would be for the parties to agree to true up, for example, every quarter. The fact that forwards are not margined daily means that, due to movements in the price of the underlying asset, a large differential can build up between the forward's delivery price and the settlement price, and in any event, an unrealized gain (loss) can build up.
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| Again, this differs from futures which get 'trued-up' typically daily by a comparison of the market value of the future to the collateral securing the contract to keep it in line with the brokerage margin requirements. This true-ing up occurs by the "loss" party providing additional collateral; so if the buyer of the contract incurs a drop in value, the shortfall or variation margin would typically be shored up by the investor wiring or depositing additional cash in the brokerage account.
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| In a forward though, the spread in exchange rates is not trued up regularly but, rather, it builds up as unrealized gain (loss) depending on which side of the trade being discussed. This means that entire unrealized gain (loss) becomes realized at the time of delivery (or as what typically occurs, the time the contract is closed prior to expiration) - assuming the parties must transact at the underlying currency's spot price to facilitate receipt/delivery.
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| The result is that forwards have higher [[credit risk]] than futures, and that funding is charged differently.
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| In most cases involving institutional investors, the daily variation margin settlement guidelines for futures call for actual money movement only above some insignificant amount to avoid wiring back and forth small sums of cash. The threshold amount for daily futures variation margin for institutional investors is often $1,000.
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| The situation for forwards, however, where no daily true-up takes place in turn creates '''credit risk''' for forwards, but not so much for futures. Simply put, the risk of a forward contract is that the supplier will be unable to deliver the referenced asset, or that the buyer will be unable to pay for it on the delivery date or the date at which the opening party closes the contract.
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| The margining of futures eliminates much of this credit risk by forcing the holders to update daily to the price of an equivalent forward purchased that day. This means that there will usually be very little additional money due on the final day to settle the futures contract: only the final day's gain or loss, not the gain or loss over the life of the contract.
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| In addition, the daily futures-settlement failure risk is borne by an exchange, rather than an individual party, further limiting credit risk in futures.
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| '''Example:'''
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| Consider a futures contract with a $100 price: Let's say that on day 50, a futures contract with a $100 delivery price (on the same underlying asset as the future) costs $88. On day 51, that futures contract costs $90. This means that the "mark-to-market" calculation would requires the holder of one side of the future to pay $2 on day 51 to track the changes of the forward price ("post $2 of margin"). This money goes, via margin accounts, to the holder of the other side of the future. That is, the loss party wires cash to the other party.
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| A forward-holder, however, may pay nothing until settlement on the final day, potentially building up a large balance; this may be reflected in the mark by an allowance for credit risk. So, except for tiny effects of convexity bias (due to earning or paying interest on margin), futures and forwards with equal delivery prices result in the same total loss or gain, but holders of futures experience that loss/gain in daily increments which track the forward's daily price changes, while the forward's spot price converges to the settlement price. Thus, while under [[mark to market]] accounting, for both
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| :assets the gain or loss [[accrual|accrues]] over the holding period; for a futures this gain or loss is realized daily, while for a forward contract the gain or loss remains unrealized until expiry.
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| Note that, due to the [[path dependence]] of funding, a futures contract is ''not,'' strictly speaking, a [[Option style#American and European options|European-style]] derivative: the total gain or loss of the trade depends not only on the value of the underlying asset at expiry, but also on the path of prices on the way. This difference is generally quite small though.
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| With an exchange-traded future, the clearing house interposes itself on every trade. Thus there is no risk of counterparty default. The only risk is that the clearing house defaults (e.g. become bankrupt), which is considered very unlikely.
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| ==Further reading==
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| * [http://www.nfa.futures.org/ The National Futures Association] (2006). ''[http://www.nfa.futures.org/nfa-investor-information/publication-library/opportunity-and-risk-entire.pdf An Educational Guide to Trading Futures and Options on Futures]''. Chicago, Illinois.
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| ==See also==
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| * [[1256 Contract]]
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| * [[Commodity Exchange Act]]
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| * [[FiftyFifty Brewing Company]]
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| * [[Freight derivatives]]
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| * [[Fuel price risk management]]
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| * [[Grain Futures Act]]
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| * [[List of finance topics]]
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| * [[List of traded commodities]]
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| * [[London Metal Exchange]]
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| * [[Oil-storage trade]]
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| * [[Onion Futures Act]]
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| * [[Prediction market]]
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| * [[Seasonal spread trading]]
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| * [[Single-stock futures]]
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| ==Notes==
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| {{Reflist}}
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| ==References==
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| * {{cite book |title=Financial Derivatives: An Introduction to Futures, Forwards, Options and Swaps |last=Redhead |first=Keith |authorlink= |coauthors= |year=1997 |publisher=Prentice-Hall |location=London |isbn=0-13-241399-X |pages= |url= }}
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| * {{cite book |title=Dynamic Asset Allocation with Forwards and Futures |last=Lioui |first=Abraham |authorlink= |coauthors=Poncet, Patrice |year=2005 |publisher=Springer |location=New York |isbn=0-387-24107-8 |pages= |url= }}
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| * {{cite book |title=An Introduction To Global Financial Markets |last=Valdez |first=Steven |authorlink= |coauthors= |year=2000 |edition=3rd |publisher=Macmillan Press |location=Basingstoke, Hampshire |isbn=0-333-76447-1 |pages= |url= }}
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| * {{cite book |title=Derivatives: A Comprehensive Resource for Options, Futures, Interest Rate Swaps, and Mortgage Securities |last=Arditti |first=Fred D. |authorlink= |coauthors= |year=1996 |publisher=Harvard Business School Press |location=Boston |isbn=0-87584-560-6 |pages= |url= }}
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| ==U.S. Futures exchanges and regulators==
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| * [[Chicago Board of Trade]], now part of [[CME Group]]
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| * [[Chicago Mercantile Exchange]], now part of [[CME Group]]
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| * [[Commodity Futures Trading Commission]]
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| * [[National Futures Association]]
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| * [[Kansas City Board of Trade]]
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| * [[New York Board of Trade]] now ICE
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| * [[New York Mercantile Exchange]], now part of [[CME Group]]
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| * [[Minneapolis Grain Exchange]]
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| ==External links==
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| * [http://www.cmegroup.com/product-codes-listing/ CME Group futures contracts product codes]
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| * [http://rjofutures.rjobrien.com/glossary/ Trading terms glossary]
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| {{derivatives market}}
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| {{DEFAULTSORT:Futures Contract}}
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| [[Category:Articles with inconsistent citation formats]]
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| [[Category:Derivatives (finance)]]
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| [[Category:Margin policy]]
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