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Finance and capital markets
Unit 9: Lesson 2
Forward and futures contracts- 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
- Backwardation
- 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
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Motivation for the futures exchange
How an exchange can benefit from trading futures and how it can use margin to mitigate its risk. Created by Sal Khan.
Want to join the conversation?
I don't quite understand how can they pre-determine the price?(5 votes)
That is the speculative side of these products. Traders predict the price of a product in the future. For these predictions they tend to look to the price of the product in the past and to recent developments that might influence the price in the future. Every trader has their own calculations/predictions. If the future on the stock market is sold for less than their prediction they will buy the future. On the other hand, if the future on the stock market is sold for more than their prediction they will try to sell their futures.
It is kind of hard to explain, but I hope you understand it some more now.(18 votes)
So the exchange dude is basically ripping off the Buyers of his Futures contract?(4 votes)
He is benefitting in some ways, but his Guarantee of the contracts acts as insurance for the other parties. He is acting like insurance.(6 votes)
What does the Exchange guy do if there are much more sellers than buyers and he have an overstock of apple wit no one to sell too. Does he loses money in this case?(4 votes)
If the exchange realizes that the number of sellers are disproportionately more than the buyers, the price of the apples will plummet, and consequently the price of any futures contract on apples will also plummet, to the point where the exchange closes trading on apples.(3 votes)
- How exactly will the futures contract price move against them does it have something to do with how much competitors are charging.(4 votes)
It can be for many reasons. E.g. if the farmer sells his apples for $1000. A month later there is a drought n another part of the country ad the price of apples will go up, the price move against him because he could have made more money if e didn't sell. Conversely the price will move against the buyer if there is a sudden supply input to the market and the price go down.(3 votes)
- Who writes or makes the Futures contract?
Does the Exchange make them?(3 votes)- There are brokers who operate on the exchange and are there to take the other side of the contracts people want to buy or sell.(2 votes)
- Okay why would any farmer not directly enter into a contract with the customer so as to get a higher price ? Why would anyone go to the exchange if they know that they can get a higher price on otc's?(1 vote)
- A regulated exchange guarantees against default. If the person on the other side of the contract defaults you will still be able to buy/sell like the contract stipulates. The exchange is the buyer for every seller and the seller for every buyer.
In the OTC market there is always a threat of default. If the counter-party defaults, you lose your money. So, while there are benefits in the OTC market such as customized contracts and less transparency, there is always the threat of default.(3 votes)
- I don't understand what, besides a computer algorithm (maybe?) makes the price of any commodity "move" up or down w/out any news, especially in jumpy, volatile ways, and WHO, or What adjusts/monitors that computer-algorithm?
I've asked this b4 of "knowlegible" folk, but they can't really answer that Q directly, clearly. So it makes one wary of who's/what's really moving all markets. ?(2 votes)- The price is the result of thousands of people transacting. People's opinions and forecasts change for a wide variety of reasons, and the price moves accordingly. There's no algorithm or other central mechanism setting the price.(2 votes)
- People who want to buy Apples in the future goes to the Future's Contract Exchange.
People who want to sell Apples in the future goes to the Future's Contract Exchange.
What happens now.
Does the Exchange sell Future's Contract to the Apple farmers and tell them the Settlement Price is$0.20/lb and tells the people who want to buy the Apples that the Settlement price will be $0.22/lb?
Does the Exchange actually buy the Apples from the farmers at Settlement Date and then give those Apples to the Apples buyers?
Sal said Future's Contract can be traded, HOW!
I'm so darn confused.(2 votes)- You might want to learn about options first. Or maybe even stocks, if you have not learned about them yet. It really seems like you are in way over your head with the futures..(1 vote)
- How to value an option contract?(1 vote)
- There are many theoretical models but a popular one is Black Scholes.(1 vote)
- what are the similarities and differences among options,futures,swaps,hedged and leverage(1 vote)
Video transcript
Male voiceover: You might be wondering
why the exchange would be willing to take on the counter party
risk for people trained, exchanging these kinds of
standardized Futures Contract. The first reason is that
the exchange actually stands to make a lot of money. What he can do is tell these people who wanna buy apples in the future, he could say for example, "Hey, you
can enter into a Futures Contract " with a settlement price
of 22 cents per pound." So that's what they're going to
have to come to the table with. That is 22 cents per pound
and he could tell the people who are gonna deliver the apples that when you deliver the apples, the settlement price
is 20 cents per pound. Essentially, when the settlement occurs, he's going to be able
to make a 2 cent profit. Let me review that again. If he only has to pay these guys
20 cents a pound for the apples, and these guys are paying 22
cents a pound for the apples, maybe I should make this
arrow go in this direction because this is the flow
of the actual money. If these guys are going to
pay 22 cents for the apples and then as the exchange, this guy only has to give
20 cents to the farmers, he's going to make 2 cents profit. On Futures Contracts, on
1,000 pounds of apples that's going to be $20 for
each of those contracts. That's going to be $20 per contract and he's going to be
doing this night and day, trading with all of the different farmers and all of the different customers and even some speculators
who might wanna do this. So maybe if the spread, if we kind of can maintain this 2 cents spread, he'll keep making $20 every time one of these Futures Contracts exchange hands. Now, the other way that he's
going to protect himself against losses is he's going to make each of these parties set
aside some money in case, the Futures Contract
price moves against them and this money that they have
to set aside is called Margin and I'll explain this in more
detail in the future video but what it essentially
is, is the amount of money that this guy or the largest
amount that this guy thinks that the Futures price might move by, the contract price might
move by any given day and so, he has a cushion. He can actually use the
margin as kind of insurance so he can make sure that
on the settlement date, both parties will kind of be able to meet their obligations. I'll go into more detail
with that on the next video on exactly how margin works.