Finance and capital markets
- Forward contract introduction
- Futures introduction
- Motivation for the futures exchange
- Futures margin mechanics
- Verifying hedge with futures margin mechanics
- Futures and forward curves
- Contango from trader perspective
- Severe contango generally bearish
- Backwardation bullish or bearish
- Futures curves II
- Contango and backwardation review
- Upper bound on forward settlement price
- Lower bound on forward settlement price
- Arbitraging futures contract
- Arbitraging futures contracts II
- Futures fair value in the pre-market
- Interpreting futures fair value in the premarket
Futures Introduction. Created by Sal Khan.
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- What is the difference between "futures contracts" and "forward contracts"?(29 votes)
- Three main differences:
1. Futures contract are standardized, forwards can be negotiated by the transacting parties
2. Futures contract are traded on the exchange and hence can be bought and sold to others. Forwards are only agreement between two parties
3. Futures the parties are not exposed to counterparty risk, the exchange assumes it. Forwards the transacting parties assume the counterparty risk(21 votes)
- I'd be interested to see how futures look like in the real world. What are the main exchanges where they're traded?(42 votes)
- In order to avoid regulations, futures traders will trade 'over the counter' (OTC) and on the Inter Continental Exchange (ICE). 'Over the counter' means not on any real exchange, like street vendors haggling, and the Inter Continental Exchange is based in London but headquartered in Atlanta. So because it is a European exchange, the CFTC has no juridiction, but the thing is, you can trade American futures in a European market. Smart people.
I think some online brokers allow you to trade futures, but mine doesn't, so I don't know.(29 votes)
- Is future considered a derivative?(12 votes)
- yes, because the value of the future is derived from the underlying item (whether its gold, pork bellies or what have you.)(8 votes)
- If the exchange assumes all the risk then why would the loosing party ever adhere to the contract?
ie. would'nt the farmer just break the contract if apple prices go to $0.30/lb?(3 votes)
- The exchange doesn't assume all the risk, it just guarantees fulfillment of the contract. Buyers and sellers of contracts on the exchange have to keep money in their accounts sufficient to cover their positions. The point of the guarantee is just so that all parties know they can feel secure that both sides of the contract will be upheld.(5 votes)
- I thought that futures must be settled daily. Is this incorrect or just a nuance of a certain type of futures contract?(3 votes)
- Correct, the prices of futures contracts are marked-to-market daily with the settlement price determined by the clearinghouse. Based on this price, any gains/losses between the parties are settled daily.(1 vote)
- Is a future considered a derivative?(3 votes)
- It already been asked, the answers:
-Yes, the contract is derived from the underlying asset; i.e., the apples.
-futures, options & swaps are the three main derivatives available in the market!(2 votes)
- So... on a serious note; what do you call the guy in the middle? The "middle man"?(2 votes)
- Which parties do use forwards more and which parties are using futures more?
Where are they mostly used in real life?
Am I thinking correctly, that forwards are used mostly by big business. like between oil companies and airline companies, but futures are used by minor parties - smaller businesses? That is - forwards are used for serious things, who cares about underlying contract, while futures are more used for speculation, right?(2 votes)
- It has nothing to do with the seriousness of the transaction. Forward contracts tend to be used when there are few sellers and few buyers, and so yes it is mostly large businesses. Future contracts tend to be used when there are many, many buyers and sellers, and so will be used for large markets.(4 votes)
After the farmer and the pie chain get involved in this forward contract, a few questions start to pop up in each of their minds. The main one is, what if the other party isn't able to uphold their end of the contract? And this is called counterparty risk, which is essentially, the counterparty to the farmer is the pie store. And the counterparty to the pie chain is the farmer. It is the risk that the other party won't be able to uphold their end of the contract. The other thing that starts to worry either one of these is what if they start to have second thoughts about this forward contract they entered into. Would they be able to maybe sell their obligation to someone else? So is there any way to trade the contract? And then there's another issue, that even if you were to trade the contract, how do we know that the other party to the whoever you might want to trade with would be cool with a million pounds, or $200,000. Maybe they would want to deal with a smaller quantity. Maybe they would only want 1,000 pounds or $100,000 worth of apples. So the local brain comes up with an idea. He's like, why don't we standardize these forward contracts? Why don't I just create a bunch of contracts, whenever someone wants to enter to one of these forward contract, but I standardize them. And I say that it is 1,000, instead of having a million apples, I do a small enough increment. So I say 1,000 pounds of apples for the delivery on let's say on November 15. And every one of these contracts say the same thing. 1,000 pounds of apples for delivery on 11/15. And this guy, he's also the richest guy in town. He's already been running a stock exchange. And so to help alleviate the counterparty risk fear, he also says that I'm going to guarantee any of these contracts. So essentially he's taking on all of the counterparty risk to make people more comfortable with trading. So all of a sudden, what happens is that now these guys don't have to do a one off contract. They don't have to do this one off the forward contract. There are these standardized contracts that this exchange can now trade. And what happens is that smaller farmers. Let me do this in a different color. You have farmer A, farmer B. Farmer B can now can now transact with, I should say, I guess we could call it customer C and customer D. Where they could agree to have a fixed price, but they could do smaller increments, more granular increments. And if any of them want to get out of it, they can by selling their contract to another person on the exchange. And these more standardized forward contracts, they're still essentially the same thing. They're just standardized. They're agreements to transact at a future date, give a certain amount of money for a certain amount of something else. It could be a security. It could be apples. These things, these standardized forward contracts, these are called futures, where they're standardized, and they are traded on an exchange.