futures

Accounting

Futures

Contracts and Clearing

A

Chapter 21: Futures © Oltheten & Waspi 2012

Futures Spot

immediate delivery and payment (settlement is generally within three business days)

Forward Delivery and payment at some specified future date

Future Delivery and payment at some specified future date The contract is standardized so that the identity of

the buyer or seller is immaterial. The only thing that needs to be negotiated is the

price.

Chapter 21: Futures

Soybean Futures

5,000 bushels No 2 yellow soybeans

with a maximum of 14% moisture

For deliveryNovember

(November 1510:01 am Chicago)

Buy at: ________ ¢ per bushel

Soybean Futures

5,000 bushels No 2 yellow soybeans

with a maximum of 14% moisture

For deliveryNovember

(November 1510:01 am Chicago)

Sell at: ________ ¢ per bushel

431 431

The Contract


Susan Speculator George Q. FarmerBuy 10 Nov Soybean contracts@ 431

Sell 10 Nov Soybean contracts@ 431

In November Susanwill take delivery of 10*5,000 = 50,000 bushelswill pay 10*5,000*431 = $215,500

In November Georgewill deliver 10*5,000 = 50,000 bushels of soybeanswill receive 10*5,000*431 = $215,500

Open Interest is 10 contracts

The Contract


Contract Risk Since settlement is months away there is

always an incentive to renege on the contract by one of the contract parties.


Susan Speculator George Q. Farmer

Buy 10 Nov Soybean contracts@ 431[$215,500]

Sell 10 Nov Soybean contracts@ 431[$215,500]

Contract Risk (price drops to 400)

The soybeans Susan has promised to buy are worth $200,000

If I renege then I save myself the

$15,500 loss


Susan Speculator George Q. Farmer

Buy 10 Nov Soybean contracts@ 431[$215,500]

Sell 10 Nov Soybean contracts@ 431[$215,500]

Contract Risk (price rises to 500)

The soybeans George has promised to sell are worth $250,000

If I renege then I save myself the

$34,500 loss


Contract Risk As soon as the price moves the contract is

at risk

If the price goes down then honoring the contract

loses me money

If the price goes up then honoring the contract

loses me money


Contract Risk A successful market for Futures contracts

must guarantee that buyers and sellers honor their agreements, regardless of subsequent price movements.

This is the role of the Clearinghouse


The Clearinghouse The Clearinghouse, in order to guarantee

delivery Imposes an initial margin on both buyers and

sellers Marks to Market at the close of trading every

trading day Imposes daily maintenance margin on both

buyers and sellers


Contract Definition On the CBOT Soybean future contract

One contract is 5,000 bushels #2 yellow soybeans

Initial margin is $810 per contract Maintenance margin is $600 per contract Price limit of 45¢ per day

The Exchange defines the contract

Chapter 21: Futures

The Contract

November 15

DeliverySell pay $8100 for the contract

Buy pay $8100 for the contract

Deliver 50,000 bushels receive $215,500 for the soybeans

Take delivery of 50,000 bushels pay $215,500 for the soybeans


Example In the following example we will follow the

actions of the Clearinghouse as prices change Day 1: 431 Day 2: 441 Day 3: 442 Day 4: 430 Day 5: 436 Day 6: 436

Chapter 21: Futures

Example

Sell 10 * 5,000 bushels soybeans at

431[$215,500]

Buy 10 * 5,000 bushels soybeans at

431[$215,500]

Chapter 21: Futures

Buy 10 @ 431 [$215,500]

Price ActionProfit Margin

Account EquityDay’s Cumulative431 Initial Margin 0 0 $8,100 $8,100

Susan: Initial Margin

Initial Margin is deposited to margin account

Which creates Equity

Chapter 21: Futures

Buy 10 @ 431 [$215,500]


Account EquityDay’s Cumulative431 Initial Margin 0 0 $8,100 $8,100441[$220,500]

Mark toMarket $5,000 $5,000 $13,100

Susan: day 2

$8,100.+5,000.

$13,100.

Equity:If Susan could sell her contract at 441

she would get … her margin back ($8,100)

plus profit ($5,000)$13,100.


Buy 10 @ 431 [$215,500]



Mark toMarket $5,000 $5,000 $13,100

442[$221,000]

Mark toMarket $500 $5,500 $13,600

Susan: day 3

$13,100.+500.

$13,600.

$8,100.+5,500.

$13,600.

Day-to-day Since inception


Buy 10 @ 431 [$215,500]



Mark toMarket $5,000 $5,000 $13,100

442[$221,000]

Mark toMarket $500 $5,500 $13,600

430[$215,000]

Mark toMarket - $6,000 - $500 $7,600

$13,600.-6,000.$7,600.

$8,100. -500.$7,600.

Day-to-day Since inception

Susan: day 4


Buy 10 @ 431 [$215,500]



Mark toMarket $5,000 $5,000 $13,100

442[$221,000]

Mark toMarket $500 $5,500 $13,600

430[$215,000]

Mark toMarket - $6,000 - $500 $7,600

436[$218,000]

Mark toMarket $3,000 $2,500 $10,600

Susan: day 5

$7,600.+3,000.

$10,600.

$8,100.+2,500.

$10,600.


Buy 10 @ 431 [$215,500]


Account EquityDay’s Cumulative431 Initial Margin 0 0 $8,100 $8,100441 [$220,500]

Mark toMarket $5,000 $5,000 $13,100

442[$221,000]

Mark toMarket $500 $5,500 $13,600

430[$215,000]

Mark toMarket - $6,000 - $500 $7,600

436[$218,000]

Mark toMarket $3,000 $2,500 $10,600

Sell 10 @ 436 [$218,000] $0 $2,500 -$10,600 0

Susan: Close

margin back: $8,100.plus profit: $2,500.

$10,600.


Susan Susan has earned a profit of $2500 on an

initial investment of $8,100

That’s a return of 30.9% over 5 days. If I annualize that…


Sell 10 @ 431 [$215,500]


Account EquityDay’s Cumulative431 Initial Margin 0 0 $8,100 $8,100

George: Initial Margin

Initial Margin is deposited to margin account

Which creates Equity


Sell 10 @ 431 [$215,500]



Mark to Market - $5,000 - $5,000 $3,100

This is below the maintenance level of $600 per contract so George gets a margin call.

George: Maintenance Margin

$8,100.-5,000.$3,100.


Sell 10 @ 431 [$215,500]

Price Action

Profit Deposit toMarginAccount Equity

Day’s Cumulative

431 Initial Margin 0 0 $8,100 $8,100441[$220,500]

Mark to MarketMargin Call

-$5,000 -$5,000$5,000

$3,100$8,100

The margin call requires George to bring his equity back to the initial level of $810 per contract.

George: Margin Call

$3,100.+margin call.

$8,100.


Sell 10 @ 431 [$215,500]



Mark to MarketMargin Call -$5,000 -$5,000 +$5,000

$3,100$8,100

442[$221,000]

Mark toMarket -$500 -$5,500 $7,600

Equity is still above the maintenance level so no margin call.

$8,100. -500.$7,600.

$13,100.-$5,500.$7,600.

George: day 3


Sell 10 @ 431 [$215,500]




-$5,000 -$5,000+$5,000

$3,100$8,100

442[$221,000]

Mark toMarket - $500 - $5,500 $7,600

430[$215,000]

Mark toMarket +$6,000 + $500 $13,600

George: day 4

$7,600. +6,000.$13,600.

$13,100.+500.

$13,600.


Sell 10 @ 431 [$215,500]




- $5,000 - $5,000$5,000

$6,100$8,100

442[$221,000]

Mark toMarket -$500 -$5,500 $7,600

430[$215,000]

Mark toMarket + $6,000 + $500 $13,600

436[$218,000]

Mark toMarket - $3,000 - $2,500 $10,600

$13,600. -3,000.$10,600.

$13,100.-$2,500.$10,600.

George: day 5


Sell 10 @ 431 [$215,500]




- $5,000 - $5,000$5,000

$6,100$8,100

442[$221,000]

Mark toMarket -$500 -$5,500 $7,600

430[$215,000]

Mark toMarket

+ $6,000 + $500 $13,600

436[$218,000]

Mark to MarketWithdrawal

- $3,000 - $2,500-$2,500

$10,600$8,100

George: Withdrawal

$10,600.-Withdrawal.

$8,100.

Equity is still above the maintenance level so no margin call.


George George has, in total, deposited $10,600 to

margin.

I am paying $10,600 to avoid the risk on my

soybeans

$8,100. +5,000 -2,500.$10,600.


Clearinghouse

What happens to George when Susan wants to close her position?

Sell 10 contracts

Buy 10 contracts

I want my $2,500 profitI want out.

I grow soybeans.I need those contracts


Clearinghouse

What happens to George when Susan wants to close her position?

The Clearinghouse cancels offsetting positions

Sell 10 contracts

Buy 10 contractsSell 10 contracts

Buy 10 contracts


Clearinghouse

The Clearinghouse cancels offsetting positions.

Sell 10 contracts

Buy 10 contractsSell 10 contracts

Buy 10 contracts


Clearinghouse

The Clearinghouse cancels offsetting positions, allowing Susan to walk away with her profit/loss matches George’s sell to John’s buy.

$2,500.


Clearinghouse Technically, Susan, George, and John have

contracts, not with each other, but with the Clearinghouse.

George:Sell 10 Soybeans$215,500

John:Buy 10 Soybeans$218,000

Susan:Buy 10 Soybeans $215,500

Clearinghouse

Sell 10 Soybeans$218,000


Clearinghouse Without the Clearinghouse

Susan would have to wait until November Take delivery of 50,000 bushels of soybeans

and pay $215,500 Deliver 50,000 bushels of soybeans and receive

$218,000 The Clearinghouse allows her to realize her

profits now without ever having to touch any soybeans


Delivery The contract trades until the business day

before the 15th of the month The contract delivers two business days

after trading stops. On the last day of trading

the futures price is 400¢ The spot price is $4.00 At delivery the Basis (spot – future) is 0

Chapter 21: Futures

Sell 10 @ 431 [$215,500]Total Margin deposited to date - $10,600Deliver 50,000 bushels of soybeans on contract Margin

Delivery$10,600

$215,500Total income from soybean farming $215,500

George: Deliver


Sell 10 @ 431 [$215,500]Total Margin deposited to date - $10,600Buy 10 @ 400 [$200,000]on the last day of trading

MarginProfit

$10,600$15,500

Sell 50,000 bushels of soybeans on the spot market @$4.00 $200,000Total income from soybean farming $215,500

George: Reverse


Futures Contracts Less than 2% of futures contracts actually

deliver Even George finds it easier to sell his

soybeans to his local grain elevator than to deliver to Chicago.

George uses futures contracts, not to sell soybeans, but to reallocate his price risk on soybeans to someone else.


Price Limits Price limit (CBOT Soybeans): 45¢ per day

400400 445

355

445 490

400

490 535

445Can trade at 500


Futures Hedge Speculate Arbitrage

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