THE PROPERTIES OF THE FUTURES MARKETS
The futures markets are the special forms of the forward markets. There are several differences between two markets. The most important differences are:
The organized exchange
The standard contracts
The transfer right and the delivery
THE ORGANIZED EXCHANGE
In the futures markets ,all trading is conducted on the organized exchange on the contrary of the forwards markets. The firms and the persons who are the members can trade in these exchanges. The membership rights can be sold or rented. The members can be assigned to the positions in the audit , the public relations and the administrative committees .
Certain exchanges which want to increase their trading volume formed the special licenses for the traders who are not their members.
The transactions are realized in the "pit". The open out cry methods are used in these exchanges . But certain exchanges have used the computerized systems since 1993.
THE STANDARD CONTRACTS
The buyers and the sellers decide themselves the price , the quantity and the delivery place of the goods . But the standard contracts are used in the futures markets. Each of the contracts contain the description ,the quantity and the delivery place of the goods. The delivery date is determined by the exchanges according their structures. For example while the delivery months are March , June , September and December in IMM , these are January, February, March , April , June , August , October and December in COMEX.
The other standard is about the price increase. The price of each futures contracts can increase or decrease according to the amount decided previously. This minimum price change is called as "tick". For example the tick for US T-Bill futures contracts in Mid America Commodity Exchange is 12,5$. The price change is 12,5 and the multiple of 12,5$.
The delivery is controlled very seriously. For example the Board of Trade determines the delivery conditions. The delivery is completed when the receipts are given by the warehouses approved by the Board of Trade.
The most important institution of the futures markets is the Clearinghouse. Its function is to match the futures operations, to control the financial straightness of the operations and to provide the delivery conditions. The Clearinghouse is acting as a buyer to the seller and a buyer to the seller. If one of the sides cannot realize his obligations , the Clearinghouse undertakes its obligations. The buyer can close out his position by buying the contracts (the seller by selling the contracts) which have the same specifications before the expiration date. For this reason the quantity of the physical delivery is small. The number of the contracts which are carried to the expiration date and are the subject of the physical delivery is only 2-3% of all the contracts. The Clearinghouse is acting as an intermediary during the trade and guarantees the realization of the commitments.
There are two kinds of organizations for the Clearinghouse:
1- The Clearinghouse is a part of the exchange. All of the members of the exchange are also the members of the Clearinghouse. This application is prevalent in USA.
2- The Clearinghouse can be organized apart from the exchange. The members of the exchange are not the members of the exchange at the same time. The great companies, the financial institutions and certain members of the exchange can be the members of the Clearinghouse, such as the Clearinghouse in London.
The funds of the Clearinghouse is provided by the initial margins and the commissions paid by the members. The Clearinghouse can also want from its members to undertake the obligations of the members who cannot accomplish their obligations. Risk dispersion is realized according to the trading volume and the unclosed position of the members.
One of the particularities which provides the security of the futures markets is the margin. The buyer of the futures markets must pay the margin to his brokerage firm when he orders to buy or sell a futures contract,the brokerage firm must pay the margin to the Clearinghouse. The first margin is called as an initial margin. There is a second margin called maintenance margin.This is a minimum margin level. The margin account of the investor diminishes as the amount of the price decrease and increases as the amount of the price increase. This situation is called daily settlement. If the margin account of the investor falls under the level of the maintenance margin, the Clearinghouse wants the investor to bring his account to the initial margin level. The amount of the margin is 2-10 % of the contract value. The maintenance margin is 75% of the initial margin. The margin can be cash, a letter of credit or a short term Treasury Bill. The margin application is a preliminary between the traders for reducing the market risk. When the margin is too high the risk of defaulting will augment so only the investors who can undertake this risk will trade in these markets. If the margin is too low , the reverse price movements can not be compensated. Even if the investor who lose cannot accomplish his obligations , the sufficient fund which is equal to his gain is collected in the account of the other part due the margin application.
The margin level is too low according to the contract value so you can buy the futures contracts which have the greater value by using a small amount of money. You can have 100% of the return of the products by a margin equal to the 2-10 % of the contract value. This high leverage level arouse the investors interest to the futures markets. There is not sufficient evidence which shows that high margin level controls price volatility. Low margins enables the speculative positions and can cause the price volatility.
The difference between the equities of two sides are not equal to the difference between the values at the beginning and the expiration date of the contracts. Because you can have the profit by investing the gain that is in your account to the short term investments or you can borrow (and pay the interest) for the purpose of the compensation of your loss in the margin account. This difference is called a margin variation risk. But this risk does not exist in the forward markets which have not the daily settlement application.
THE TRANSFER RIGHT AND THE DELIVERY
You cannot transfer the forward contracts to the third persons but this right is possible in the futures markets. The buyer of the futures contracts can sell the futures contracts which have the same specifications to the third person and he can close out his position. Thus he can transfer his obligations that he undertake when he bought the futures contracts. The situations that the physical deliveries are occurred are seldom. The exchanges which want to increase their trading volume and to arose the investors interest facilitate the delivery process. They allow to deliver the goods that have different properties and qualities indicated in the contracts by using the different price , if the depth of the market of the goods is not sufficient. In this situation the price adjustment is realized according to the deviation from the contract conditions .
It is allowed to the cash settlement instead of the delivery for the futures contracts concerning certain products and financial instruments. This payment is realized according to the closing price at the expiration date of the contract : For example the eurodollar futures contracts in CME and the stock index futures contracts in various exchanges. Particularly the physical delivery of the portfolio formed by all of the stocks which form the index is very difficult.