Forward and Futures
Forward Contracts
• A forward contract is an agreement to buy
or sell an asset at a certain time in the future
for a certain price (the delivery price)
• It can be contrasted with a spot contract
which is an agreement to buy or sell
immediately
• It is traded in the OTC market
Forward Price
• The forward price for a contract is the
delivery price that would be applicable
to the contract if were negotiated
today (i.e., it is the delivery price that
would make the contract worth exactly
zero)
• The forward price may be different for
contracts of different maturities
Terminology
• The party that has agreed to buy
has what is termed a long position
• The party that has agreed to sell
has what is termed a short position
Profit from a
Long Forward Position
Profit
K
Price of Underlying
at Maturity, ST
Profit from a
Short Forward Position
Profit
K
Price of Underlying
at Maturity, ST
Futures Contracts
• Agreement to buy or sell an asset for a
certain price at a certain time
• Similar to forward contract
• Whereas a forward contract is traded
OTC, a futures contract is traded on an
exchange
Crude Futures at NYMEX
Jan 8, 2008
•
•
•
•
•
•
•
Feb 2008
Mar 2008
April 2008
May 2008
June 2008
July 2008
Last
96.23
95.93
95.50
95.29
94.65
94.51
Natural Gas at NYMEX
Jan 8, 2008
•
•
•
•
•
•
•
Feb 2008
Mar 2008
April 2008
May 2008
June 2008
July 2008
Last
7.945
7.960
7.932
7.976
8.047
8.100
Jan 8, 2008
• Gold
• Silver
• Copper
880.80
15.820
3.2840
Dec 31, 2009
•
•
•
•
•
Crude oil: 79.54
Natural gas: 5.572
Gold: 1096.4
Silver: 16.822
Copper: 3.3275
The importance of commodities
• With the increasing scarcity of
commodities, commodity prices will be
very volatile, which will create many
trading opportunities.
• Commodity trading desks are the fastest
expanding operations in major banks
• Commodity traders become the best paid
in financial markets.
Margins
• A margin is cash or marketable securities
deposited by an investor with his or her broker
• The balance in the margin account is adjusted to
reflect daily settlement
• Margins minimize the possibility of a loss
through a default on a contract
• Example of default: HKFE in October, 1987
• A history of margins in HKFE, 4, 5, 8, 10, now?
Exercise
On Jan 8, 2008, the May 2008 natural gas futures
traded at NYMEX was quoted at 7.976 per (mmBtu).
On April 9, 2008, the May 2008 natural gas futures
traded at NYMEX was quoted at 10.090 per (mmBtu).
Each contract represents 10,000 million British thermal
units (mmBtu). The initial margin is 6600 dollars per
contract. Please calculate the total profit from buying
one natural gas futures contract at Jan 8 and closing
out at April 9. What is the rate of return on your
investment, assuming the amount of investment is the
initial margin required?
Commodities Futures Trading
• CME group
• Monopoly of commodity trading
• http://www.cmegroup.com/
Homework1
• On September 4, 2007, the crude oil futures traded at
NYMEX was quoted at 75.07 per barrel. On December
4, 2007, the crude oil futures traded at NYMEX was
quoted at 88.31 per barrel. Each NYMEX crude oil
futures contract represents 1000 barrels. The initial
margin for the contract, i.e., the amount of money
required to deposit into the clearing house, is 5775
dollars. Please calculate the total profit from buying one
crude oil futures contract at September 4 and closing out
at December 4. What is the rate of return on your
investment, assuming the amount of investment is the
initial margin required?
Homework2
• Continued from the last question.
• An investor believes oil price will drop
sharply and decides to short maximum
number of futures contracts. He has
30,000 dollars in a trading account. How
many crude oil futures contracts he can
short? Suppose he opened the positions
at Sept 4, 2007 and closed the positions at
Dec 4, 2007. How much money he lost in
this trade?