Futures
Contracts and Clearing
Accounting
A
Futures
 Spot
 immediate delivery and payment (settlement is
generally within three business days)
 Forward
 Delivery and payment at some specified future date
 Future
 Delivery and payment at some specified future date
 The contract is standardized so that the identity of
the buyer or seller is immaterial.
 The only thing that needs to be negotiated is the
price.
Chapter 21: Futures
© Oltheten & Waspi 2012
The Contract
Soybean Futures
Soybean Futures
5,000 bushels
No 2 yellow soybeans
with a maximum of 14% moisture
5,000 bushels
No 2 yellow soybeans
with a maximum of 14% moisture
For delivery
November
(November 15
10:01 am Chicago)
For delivery
November
(November 15
10:01 am Chicago)
431 ¢ per bushel
Buy at: ________
431
Sell at: ________
¢ per bushel
Chapter 21: Futures
The Contract
Susan Speculator
George Q. Farmer
Buy 10 Nov Soybean contracts
@ 431
Sell 10 Nov Soybean contracts
@ 431
In November Susan
will take delivery of 10*5,000
= 50,000 bushels
will pay 10*5,000*431
= $215,500
In November George
will deliver 10*5,000
= 50,000 bushels of soybeans
will receive 10*5,000*431
= $215,500
Open Interest is 10 contracts
Chapter 21: Futures
© Oltheten & Waspi 2012
Contract Risk
 Since settlement is months away there is
always an incentive to renege on the
contract by one of the contract parties.
Chapter 21: Futures
© Oltheten & Waspi 2012
Contract Risk (price drops to 400)
Susan Speculator
Buy 10 Nov Soybean contracts
@ 431
[$215,500]
George Q. Farmer
Sell 10 Nov Soybean contracts
@ 431
[$215,500]
If I renege
then I save myself the
$15,500 loss
The soybeans Susan has
promised to buy are worth
$200,000
Chapter 21: Futures
© Oltheten & Waspi 2012
Contract Risk (price rises to 500)
Susan Speculator
Buy 10 Nov Soybean contracts
@ 431
[$215,500]
George Q. Farmer
Sell 10 Nov Soybean contracts
@ 431
[$215,500]
If I renege
then I save myself the
$34,500 loss
The soybeans George has
promised to sell are worth
$250,000
Chapter 21: Futures
© Oltheten & Waspi 2012
Contract Risk
 As soon as the price moves the contract is
at risk
If the price goes down
then honoring the contract
loses me money
If the price goes up then
honoring the contract
loses me money
Chapter 21: Futures
© Oltheten & Waspi 2012
Contract Risk
 A successful market for Futures contracts
must guarantee that buyers and sellers
honor their agreements, regardless of
subsequent price movements.
 This is the role of the Clearinghouse
Chapter 21: Futures
© Oltheten & Waspi 2012
The Clearinghouse
 The Clearinghouse, in order to guarantee
delivery
 Imposes an initial margin on both buyers and
sellers
 Marks to Market at the close of trading every
trading day
 Imposes daily maintenance margin on both
buyers and sellers
Chapter 21: Futures
© Oltheten & Waspi 2012
Contract Definition
 On the CBOT Soybean future contract
 One contract is 5,000 bushels #2 yellow
soybeans
 Initial margin is $810 per contract
 Maintenance margin is $600 per contract
 Price limit of 45¢ per day
The Exchange defines the contract
Chapter 21: Futures
© Oltheten & Waspi 2012
The Contract
Buy
pay $8100 for the contract
Take delivery of 50,000 bushels
pay $215,500 for the soybeans
November 15
Delivery
Sell
pay $8100 for the contract
Chapter 21: Futures
Deliver 50,000 bushels
receive $215,500 for the soybeans
Example
 In the following example we will follow the
actions of the Clearinghouse as prices
change






Chapter 21: Futures
Day 1: 431
Day 2: 441
Day 3: 442
Day 4: 430
Day 5: 436
Day 6: 436
© Oltheten & Waspi 2012
Example
Sell 10 * 5,000 bushels
soybeans at 431
[$215,500]
Buy 10 * 5,000
bushels soybeans at
431
[$215,500]
Chapter 21: Futures
Susan: Initial Margin
Buy 10 @ 431 [$215,500]
Profit
Price
Action
431
Initial Margin
Day’s
Cumulative
0
0
Margin
Account
Equity
$8,100
$8,100
Initial Margin is deposited to margin account
Which creates Equity
Chapter 21: Futures
Susan: day 2
Buy 10 @ 431 [$215,500]
Profit
Price
Action
431
Initial Margin
441
[$220,500]
Mark to
Market
Day’s
Cumulative
0
0
$5,000
$5,000
Equity:
If Susan could sell her contract at 441
she would get …
her margin back ($8,100)
plus profit ($5,000)
$13,100.
Chapter 21: Futures
Margin
Account
$8,100
Equity
$8,100
$13,100
$8,100.
+5,000.
$13,100.
Susan: day 3
Buy 10 @ 431 [$215,500]
Profit
Price
Action
431
Initial Margin
441
[$220,500]
442
[$221,000]
$13,100.
+500.
$13,600.
Chapter 21: Futures
Day’s
Margin
Account
Cumulative
0
0
Mark to
Market
$5,000
$5,000
$13,100
Mark to
Market
$500
$5,500
$13,600
Day-to-day
$8,100
Equity
$8,100.
+5,500.
$13,600.
$8,100
Since
inception
© Oltheten & Waspi 2012
Susan: day 4
Buy 10 @ 431 [$215,500]
Profit
Price
Action
431
Initial Margin
441
[$220,500]
Day’s
Margin
Account
Cumulative
Equity
0
0
Mark to
Market
$5,000
$5,000
$13,100
442
[$221,000]
Mark to
Market
$500
$5,500
$13,600
430
[$215,000]
Mark to
Market
- $6,000
- $500
$7,600
$13,600.
-6,000.
$7,600.
Chapter 21: Futures
Day-to-day
$8,100
$8,100.
-500.
$7,600.
$8,100
Since
inception
© Oltheten & Waspi 2012
Susan: day 5
Buy 10 @ 431 [$215,500]
Profit
Day’s
Price
Action
431
Initial Margin
441
[$220,500]
Cumulative
Margin
Account
0
0
Mark to
Market
$5,000
$5,000
$13,100
442
[$221,000]
Mark to
Market
$500
$5,500
$13,600
430
[$215,000]
Mark to
Market
- $6,000
- $500
$7,600
436
[$218,000]
Mark to
Market
$3,000
$2,500
$10,600
$7,600.
+3,000.
$10,600.
Chapter 21: Futures
$8,100
Equity
$8,100
$8,100.
+2,500.
$10,600.
© Oltheten & Waspi 2012
Susan: Close
Buy 10 @ 431 [$215,500]
Profit
Price
Action
431
Initial Margin
441
[$220,500]
Day’s
Margin
Account
Cumulative
0
0
Mark to
Market
$5,000
$5,000
442
[$221,000]
Mark to
Market
$500
430
[$215,000]
Mark to
Market
- $6,000
436
[$218,000]
Mark to
Market
Sell 10 @ 436 [$218,000]
Chapter 21: Futures
$8,100
Equity
$8,100
$13,100
margin
back: $8,100.
$5,500
plus profit: $2,500.
$10,600.
$13,600
- $500
$7,600
$3,000
$2,500
$10,600
$0
$2,500
-$10,600
0
© Oltheten & Waspi 2012
Susan
 Susan has earned a profit of $2500 on an
initial investment of $8,100
That’s a return of 30.9% over 5 days.
If I annualize that…
Chapter 21: Futures
© Oltheten & Waspi 2012
George: Initial Margin
Sell 10 @ 431 [$215,500]
Profit
Price
Action
431
Initial Margin
Day’s
Margin
Account
Cumulative
0
0
Equity
$8,100
$8,100
Initial Margin is deposited to margin account
Which creates Equity
Chapter 21: Futures
© Oltheten & Waspi 2012
George: Maintenance Margin
Sell 10 @ 431 [$215,500]
Profit
Price
Action
431
Initial Margin
441
[$220,500]
Mark to
Market
Day’s
Margin
Account
Cumulative
0
0
- $5,000
- $5,000
Equity
$8,100
$8,100
$3,100
$8,100.
-5,000.
$3,100.
This is below the maintenance level of $600 per contract so
George gets a margin call.
Chapter 21: Futures
© Oltheten & Waspi 2012
George: Margin Call
Sell 10 @ 431 [$215,500]
Profit
Day’s
Price
Action
431
Initial Margin
441
[$220,500]
Mark to Market
Margin Call
Cumulativ
e
0
0
-$5,000
-$5,000
Deposit to
Margin
Account
Equity
$8,100
$8,100
$5,000
$3,100
$8,100
$3,100.
+margin call.
$8,100.
The margin call requires George to bring his equity back to the
initial level of $810 per contract.
Chapter 21: Futures
© Oltheten & Waspi 2012
George: day 3
Sell 10 @ 431 [$215,500]
Profit
Price
Action
431
Initial Margin
441
[$220,500]
Mark to Market
Margin Call
442
[$221,000]
Mark to
Market
Day’s
Cumulative
0
0
-$5,000
-$5,000
-$500
-$5,500
$8,100.
-500.
$7,600.
Margin
Account
Equity
$8,100
$8,100
+$5,000
$3,100
$8,100
$7,600
$13,100.
-$5,500.
$7,600.
Equity is still above the maintenance level so no margin call.
Chapter 21: Futures
© Oltheten & Waspi 2012
George: day 4
Sell 10 @ 431 [$215,500]
Profit
Day’s
Price
Action
431
Initial Margin
441
[$220,500]
Mark to Market
Margin Call
442
[$221,000]
Mark to
Market
- $500
- $5,500
$7,600
430
[$215,000]
Mark to
Market
+$6,000
+ $500
$13,600
0
0
-$5,000
-$5,000
$7,600.
+6,000.
$13,600.
Chapter 21: Futures
Cumulative
Margin
Account
Equity
$8,100
$8,100
+$5,000
$3,100
$8,100
$13,100.
+500.
$13,600.
© Oltheten & Waspi 2012
George: day 5
Sell 10 @ 431 [$215,500]
Profit
Day’s
Price
Action
431
Initial Margin
441
[$220,500]
Mark to Market
Margin Call
442
[$221,000]
Mark to
Market
-$500
-$5,500
$7,600
430
[$215,000]
Mark to
Market
+ $6,000
+ $500
$13,600
436
[$218,000]
Mark to
Market
- $3,000
- $2,500
$10,600
$13,600.
-3,000.
$10,600.
Chapter 21: Futures
Cumulative
Margin
Account
0
0
- $5,000
- $5,000
Equity
$8,100
$8,100
$5,000
$6,100
$8,100
$13,100.
-$2,500.
$10,600.
© Oltheten & Waspi 2012
George: Withdrawal
Sell 10 @ 431 [$215,500]
Profit
Day’s
Cumulative
Margin
Account
Price
Action
431
Initial Margin
441
[$220,500]
Mark to Market
Margin Call
442
[$221,000]
Mark to
Market
-$500
-$5,500
$7,600
430
[$215,000]
Mark to
Market
+
$6,000
+ $500
$13,600
436
[$218,000]
Mark to Market
Withdrawal
- $3,000
- $2,500
$10,600
$8,100
0
0
- $5,000
- $5,000
Equity is still above the maintenance level so no
margin call.
Chapter 21: Futures
Equity
$8,100
$8,100
$5,000
$6,100
$8,100
-$2,500
$10,600.
-Withdrawal.
$8,100.
© Oltheten & Waspi 2012
George
 George has, in total, deposited $10,600 to
margin.
$8,100.
+5,000
-2,500.
$10,600.
I am paying $10,600 to
avoid the risk on my
soybeans
Chapter 21: Futures
© Oltheten & Waspi 2012
Clearinghouse
I grow soybeans.
I need those contracts
 What happens to George when
Susan wants to close her position?
Sell 10 contracts
Buy 10 contracts
I want my $2,500 profit
I want out.
Chapter 21: Futures
© Oltheten & Waspi 2012
Clearinghouse
 What happens to George when
Susan wants to close her position?
Sell 10 contracts
Buy 10 contracts
Sell 10 contracts
The Clearinghouse cancels
Buy 10 contracts
offsetting positions
Chapter 21: Futures
© Oltheten & Waspi 2012
Clearinghouse
 The Clearinghouse cancels offsetting
positions.
Sell 10 contracts
Buy 10 contracts
Sell 10 contracts
Buy 10 contracts
Chapter 21: Futures
© Oltheten & Waspi 2012
Clearinghouse
 The Clearinghouse cancels offsetting positions,


allowing Susan to walk away with her profit/loss
matches George’s sell to John’s buy.
$2,500.
Chapter 21: Futures
© Oltheten & Waspi 2012
Clearinghouse
 Technically, Susan, George, and John have
contracts, not with each other, but with the
Clearinghouse.
Susan:
Buy 10 Soybeans
$215,500
Clearinghouse
George:
Sell 10 Soybeans
$215,500
Sell 10 Soybeans
$218,000
John:
Buy 10 Soybeans
$218,000
Chapter 21: Futures
© Oltheten & Waspi 2012
Clearinghouse
 Without the Clearinghouse
 Susan would have to wait until November
 Take delivery of 50,000 bushels of soybeans
and pay $215,500
 Deliver 50,000 bushels of soybeans and receive
$218,000
 The Clearinghouse allows her to realize her
profits now without ever having to touch
any soybeans
Chapter 21: Futures
© Oltheten & Waspi 2012
Delivery
 The contract trades until the business day
before the 15th of the month
 The contract delivers two business days
after trading stops.
 On the last day of trading
 the futures price is 400¢
 The spot price is $4.00
 At delivery the Basis (spot – future) is 0
Chapter 21: Futures
© Oltheten & Waspi 2012
George: Deliver
Sell 10 @ 431 [$215,500]
Total Margin deposited to date
Deliver 50,000 bushels of soybeans on contract
Total income from soybean farming
Chapter 21: Futures
- $10,600
Margin
Delivery
$10,600
$215,500
$215,500
George: Reverse
Sell 10 @ 431 [$215,500]
Total Margin deposited to date
Buy 10 @ 400 [$200,000]
on the last day of trading
- $10,600
Margin
Profit
$10,600
$15,500
Sell 50,000 bushels of soybeans on the spot market @$4.00
$200,000
Total income from soybean farming
$215,500
Chapter 21: Futures
© Oltheten & Waspi 2012
Futures Contracts
 Less than 2% of futures contracts actually
deliver
 Even George finds it easier to sell his
soybeans to his local grain elevator than to
deliver to Chicago.
 George uses futures contracts, not to sell
soybeans, but to reallocate his price risk on
soybeans to someone else.
Chapter 21: Futures
© Oltheten & Waspi 2012
Price Limits
 Price limit (CBOT Soybeans): 45¢ per day
535
Can trade at 500
490
445
445
400
400
355
Chapter 21: Futures
© Oltheten & Waspi 2012
Futures
 Hedge
 Speculate
 Arbitrage
Chapter 21: Futures
© Oltheten & Waspi 2012
Futures I