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8/8/2019 Ch02HullOFOD6thEd
1/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.1
Mechanics of FuturesMarkets
Chapter 2
8/8/2019 Ch02HullOFOD6thEd
2/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.2
Futures Contracts
Available on a wide range of underlyings
Exchange traded
Specifications need to be defined: What can be delivered,
Where it can be delivered, &
When it can be delivered Settled daily
8/8/2019 Ch02HullOFOD6thEd
3/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.3
Margins
A margin is cash or marketable securitiesdeposited 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 lossthrough a default on a contract
8/8/2019 Ch02HullOFOD6thEd
4/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.4
Example of a Futures Trade (page 27-28)
An investor takes a long position in 2December gold futures contracts on
June 5 contract size is 100 oz.
futures price is US$400
margin requirement is US$2,000/contract
(US$4,000 in total) maintenance margin is US$1,500/contract
(US$3,000 in total)
8/8/2019 Ch02HullOFOD6thEd
5/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.5
A Possible Outcome
Table 2.1, Page 28
Daily Cumulative Margin
Futures Gain Gain Account Margin
Price (Loss) (Loss) Balance Call
Day (US$) (US$) (US$) (US$) (US$)
400.00 4,000
5-Jun 397.00 (600) (600) 3,400 0. . . . . .. . . . . .. . . . . .
13-Jun 393.30 (420) (1,340) 2,660 1,340. . . . . .
. . . . .. . . . . .
19-Jun 387.00 (1,140) (2,600) 2,740 1,260. . . . . .. . . . . .. . . . . .
26-Jun 392.30 260 (1,540) 5,060 0
+
= 4,000
3,000
+
= 4,000
8/8/2019 Ch02HullOFOD6thEd
6/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.6
Other Key Points About Futures
They are settled daily
Closing out a futures position
involves entering into an offsettingtrade
Most contracts are closed outbefore maturity
8/8/2019 Ch02HullOFOD6thEd
7/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.7
Collateralization in OTC Markets
It is becoming increasingly common forcontracts to be collateralized in OTC
markets They are then similar to futures contracts
in that they are settled regularly (e.g. everyday or every week)
8/8/2019 Ch02HullOFOD6thEd
8/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.8
Futures Prices for Gold on Feb 4, 2004: Prices
Increase with Maturity (Figure 2.2, page 35)
(a) Gold
398399400
401402403404405406
407408
Feb-04 Apr-04 Jun-04 Aug-04 Oct-04 Dec-04
Contract M aturity Mo nth
Futures
Price
($
peroz)
8/8/2019 Ch02HullOFOD6thEd
9/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.9
Futures Prices for Oil on February 4, 2004:
Prices Decrease with Maturity (Figure 2.2, page 35)
(b) Br t Cr Oil
24
25
26
27
28
29
30
Mar-04 May-04 Jul-04 Sep-04 Nov-04 Jan-05
C tr t t rit t
t
r
ri
(
rb
rr
l)
8/8/2019 Ch02HullOFOD6thEd
10/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.10
Delivery
If a futures contract is not closed out beforematurity, it is usually settled by delivering theassets underlying the contract. When there arealternatives about what is delivered, where it isdelivered, and when it is delivered, the party withthe short position chooses.
Afew contracts (for example, those on stockindices and Eurodollars) are settled in cash
8/8/2019 Ch02HullOFOD6thEd
11/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.11
Some Terminology
Open interest: the total number of contractsoutstanding
equal to number of long positions ornumber of short positions
Settlement price: the price just before thefinal bell each day
used for the daily settlement process Volume of trading: the number of trades in 1
day
8/8/2019 Ch02HullOFOD6thEd
12/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.12
Convergence of Futures to Spot
(Figure 2.1, page 26)
Time Time
(a) (b)
FuturesPrice
FuturesPrice
Spot Price
Spot Price
8/8/2019 Ch02HullOFOD6thEd
13/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.13
Questions
When a new trade is completed whatare the possible effects on the open
interest? Can the volume of trading in a day
be greater than the open interest?
8/8/2019 Ch02HullOFOD6thEd
14/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.14
Regulation of Futures
Regulation is designed toprotect the public interest
Regulators try to preventquestionable trading practicesby either individuals on the floorof the exchange or outsidegroups
8/8/2019 Ch02HullOFOD6thEd
15/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.15
Accounting & Tax
Ideally hedging profits (losses) should berecognized at the same time as the losses(profits) on the item being hedged
Ideally profits and losses from speculationshould be recognized on a mark-to-marketbasis
Roughly speaking, this is what the
accounting and tax treatment of futures inthe U.S.and many other countries attemptsto achieve
8/8/2019 Ch02HullOFOD6thEd
16/17
Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.16
Forward Contracts vs Futures
Contracts
Private contract between 2 parties Exchange traded
Non-standard contract Standard contract
Usually 1 specified delivery date Range of delivery dates
Settled at end of contract Settled daily
Delivery or final cashsettlement usually occurs
Contract usually closed outprior to maturity
FORWARDS FUTURES
TABLE 2.3 (p. 41)
Some credit risk Virtually no credit risk
8/8/2019 Ch02HullOFOD6thEd
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Options, Futures, and Other Derivatives, 6th
Edition, Copyright John C. Hull 2005 2.17
Foreign Exchange Quotes
Futures exchange rates are quoted as thenumber of USD per unit of the foreign currency
Forward exchange rates are quoted in the sameway as spot exchange rates. This means thatGBP, EUR, AUD, and NZD are quoted as USD
per unit of foreign currency. Other currencies(e.g., CAD and JPY) are quoted as units of theforeign currency per USD.
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