Chapter 8: The Structure of Forward and
Futures Markets
It is like watching your favorite soap opera. You know all
the characters. You know the plot. But you never really
know how the day is going to end.
Turk Ozdek
Futures, July 2001, p. 86
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 1
Important Concepts in Chapter 8
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Definitions and examples of forward and futures contracts
Institutional characteristics of forward and futures markets
Futures contracts available for trading
Placing an order, margins, daily settlement
The role of the clearinghouse
Accessing futures price quotations
Magnitude and effects of transaction costs
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 2
The Development of Forward and Futures
Markets
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Chicago Futures Markets
The Development of Financial Futures
The Development of Options on Futures Markets
The Parallel Development of Over-the-Counter Markets
 interbank market
 growth of forward markets
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 3
The Over-the-Counter Forward Market
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customized
private
essentially unregulated
credit risk
market size: $18 trillion face value, $400 billion market
value at year-end 2001
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 4
Organized Futures Trading
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Contract Development
Contract Terms and Conditions
 contract size
 quotation unit
 minimum price fluctuation
 contract grade
 trading hours
Delivery Terms
 delivery date and time
 delivery or cash settlement
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 5
Organized Futures Trading (continued)
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Daily Price Limits and Trading Halts
 limit moves
 circuit breakers
Other Exchange Responsibilities
 minimum financial responsibility requirements
 position limits
 rules governing the trading floor
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 6
Futures Exchanges
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See Table 8.1, p. 279 for list of exchanges.
Global and after-hours trading
Estimated world-wide volume in 2001 was 1.8 billion
contracts.
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 7
Futures Traders
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General Classes of Futures Traders
 futures commission merchants
 locals
 dual trading
Classification by Trading Strategy
 hedger/speculator
 spreader
 arbitrageur
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 8
Futures Traders (continued)
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Classification by Trading Style
 scalpers
 day traders
 position traders
Off-Floor Futures Traders
 individuals
 institutions
 Others: Introducing Broker (IB), Commodity Trading
Advisor (CTA), Commodity Pool Operator (CPO),
Associated Person (AP)
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 9
Futures Traders (continued)
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The Cost and Profitability of Exchange Membership
 seats
 See Figure 8.1, p. 283 for history of CBOT, CME, and
NYMEX seat prices.
 leasing a seat at around 1.0 - 1.5 %/mo. of seat price
 profitability of membership
Forward Market Traders
 over-the-counter
 primarily institutions
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 10
The Mechanics of Futures Trading
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Placing an Order
 pit
 open outcry
 electronic systems
The Role of the Clearinghouse
 See Figure 8.2, p. 285.
 margin deposits
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 11
The Mechanics of Futures Trading
(continued)
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Daily Settlement
 initial margin
 maintenance margin
 concept of “margin” vs. performance bond
 settlement price
 variation margin
 See Table 8.2, p. 287 for example.
 open interest
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 12
The Mechanics of Futures Trading
(continued)
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Delivery and Cash Settlement
 three-day delivery process
 alternative deliverable grades
 offsetting
 exchange for physicals
 forward market procedures
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 13
Futures Price Quotations
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Newspapers and web sites
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 14
Types of Futures Contracts
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Agricultural Commodities
Natural Resources
Miscellaneous Commodities
Foreign Currencies
Treasury Bills and Eurodollars
Treasury Notes and Bonds
Equities
Managed Funds
Hedge Funds
Options on Futures
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 15
Transaction Costs in Forward and Futures
Trading
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Commissions
Bid-Ask Spread
Delivery Costs
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 16
The Regulation of Futures Markets
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Regulation is nearly always at the federal level; e.g.,
 Commodity Futures Trading Commission (U.S.)
 Financial Services Authority (U.K.)
 Financial Services Agency (Japan)
Objective of most federal regulation
 ensuring public information available
 authorization and licensing of contracts and
exchanges
 contract approval
 market surveillance
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 17
The Regulation of Futures Markets
(continued)
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Arbitration of disputes is sometimes done through the
federal government and the courts but often through selfregulatory organizations such as the National Futures
Association in the U. S.
Note: Forward markets are regulated only indirectly and,
thus, are largely unregulated.
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 18
Summary
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 19
Appendix 8: Taxation of Futures Contracts
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Treated as 60 % capital gains and 40 % ordinary income.
Capital gains subject to 28 % maximum.
Must be marked to market at year end.
New single stock futures are taxed the same as individual
stocks.
Hedge transactions covered in Chapter 10.
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 20
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D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 21
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D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 22
(Return to text slide)
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 23
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D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.
Ch. 8: 24