Futures Exchange
A futures exchange is the main entity where investors can buy or sell regular futures contracts; it may also called a futures market. A futures contract is a derivative agreement to buy a pre-determined number of assets or fiscal products for an agreed price at a fixed time in future. This contract is called derivative, as the worth of the contract is deduced from the value of other assets involved. The price is determined through the value of the agreed commodity that may be a property or even a bond.
Evolution of Futures Trading
Politics, a book written by Aristotle, contains the first recorded mention of futures business. The book is a tale of a thinker named Thales from the town of Miletus, who invents a monetary instrument that is applicable all over. Thales then foresees a bumper olive produce through his talent. Having full faith in his assessment he negotiates deals granting him full rights to the olive fields at the time of harvest in future, for a low price paid now. The olive farmers unsure of the future crop yield agree to low prices and sell their future rights to Thales. Thales’ prediction turns out to be true and the olives producion is very good. Olives are increasingly demanded in the markets for extraction of oil in the presses and Thales is able to sell them for a very high price. He makes a lot of money through dictating his own rates for the olives. However, keep in mind that this type of trade is more closer to the category of an Options agreement or Contract, since it was not binding for Thales to sell the olives to the presses in case of a bad crop.
Dojima Rice Exchange located in Japan, is said to be the pioneer modern exchange for futures trade and was established in 1710.
Futures exchange in the United States of America was first established in the beginning of the 19th century. The Chicago Mercantile Exchange in the States is the biggest futures market in the world. Due to its central proximity to the most productive agricultural region in the USA, Chicago is a focal market of agricultural products. The very nature of agriculture forces fluctuations in the product prices, since less yield and increased demand increases and more yield and less demand decreases prices. The fluctuating prices led the farmers and the merchants to develop a futures trading system; an exchange empowering farmers to hedge, by agreeing to “ to arrive” and “ future paid” contracts, thus enabling them a protection from fallen prices. The C M E declared the acquirement of New York Mercantile Exchange Holdings Inc in early 2008, which materialized in August 2008. NYMEX Holdings Inc is the controlling company for NYMEX and the Futures markets.
Though these types of futures contracts were quite frequent in the past, most of them were not honored either by the seller or by the buyer. It was common for traders to go back on the contract if the price at the maturity of the contract was other than their expectations. Sometimes the seller and other times the buyer would refuse to honor the contract. Furthermore, the fluidity of a future contract market called for a meeting place for both the buyers and sellers, where they could easily find interested parties to deal with. This paved the way for traders not having to look for potential customers and rather have a proper market to do the business.
The Board of Trade in Chicago (CBOT) came to be in 1848 and the initial deals were all Forward contracts. The first recorded contract in CBOT was a trade deal in corn that was agreed on 13th march 1851. Institutionalized Forward contracts were first presented in the year 1865.
The Chicago Mercantile Exchange (CME), the newer form of the previous Egg and Butter Board, was created in 1919. Chicago Butter and Egg Board were established in 1898 and was the new name given to the Chicago Produce Exchange established in 1874. The universal standard Gold, which was adopted after the end of Second World War, was abolished in 1972 and the Chicago Mercantile Exchange developed an organ to monitor foreign currencies deals in futures contracts, named the IMM or the International Monetary Market. A few foreign currencies dealing in futures trade included; Pound, Yen, German Mark and Franc.
Local market in Minneapolis, a city in Minnesota, was established in 1881, which started futures trading in 1883. The MGEX, the Grain Exchange in Minneapolis continues to trade until today and is the lone market for the local variety of wheat futures trade in the world. This red wheat harvests in the spring season and is colored red.
The futures fiscal concept of contracts was introduced in the 70s, allowing trade in the potential worth of the interest rates. Financial futures contracts and specially the Euro-Dollar ninety-day contracts of 1981 were instrumental in the creation of the exchange market on the interest rates.
The volume of futures trade today is much more than their parent agricultural products. The introduction of the New York Market abbreviated as NYMEX has further increased the gap and the futures trade volume is many times the conventional produce trade. An increasingly significant role is being played by the futures market in the world economic system through its more than one and a half trillion US dollars daily market, by hedging and trading.
Till August 2006 the Chicago Futures Market had grown to trade seventy percent of futures contracts through its trading platform of Globex. The share of the Mercantile Exchange of Chicago is nearly fifty billion dollars daily with more than one million contracts in electronic trade, as against the manual traditional methods of trading futures, option and derivative contracts.
The Intercontinental Exchange (ICE) bought the International Petroleum Exchange (IPE) and renamed it the Intercontinental Exchange futures in mid 2001. The International Petroleum Exchange (IPE) was the biggest European open-outcry futures exchange in energy sector. ICE joined hands with the Chicago CCX in 2003 to feature its digital exchange. The energy giant ICE converted its complete energy sector futures to electronic trading system.
The first transcontinental Futures and Options Exchange was born out of the handshake between the New York Stock Exchange and the “Euronext” in 2006. Euronext already was a team comprising of major European players including Amsterdam, Brussels, Lisbon, and Paris Exchanges. The above mentioned significant events and the rapid increase of web based trading platforms for futures and options point to the possibility of futures trade being shifted to electronic platforms in entirety in the times to come.
The leading futures exchange of the world in volumetric calculations is the Indian National Stock Exchange located in Mumbai, ahead of the South African JSE Limited situated at Gauteng.
Different types of contracts
Standard regulated trades are offered by the parent exchanges. All the details regarding the identity, value and quantity of the traded commodities are recorded, as well as the timings for the trade by the futures exchanges. The currency agreed for the trade is also identified along with the minimum price of the asset, and the final possible day and month for the deal to expire. A variation from the standard commodity may well be incorporated in a futures contract to adjust the agreed price in case of a deviation from the standardized financial asset, like a second grade crop may be allowed at a lower value than the agreed standard of its first grade version.
Only an understanding exists instead of a real contract on the opening day of a startup forward contract. Unlike other sureties and bonds futures contracts are created and are not issued, whenever Open interest appreciates. In other words, futures contracts are created when a party buys a contract, on offer by the sellers. On the other hand, the created futures contracts are eliminated when the open interest depreciates; the traders sell the contracts again to decrease their long-term positions, or buy them again to reduce short-term ones.
Speculators who rely on fluctuations in potential rates and have no plans to either buy or sell at the maturity of the futures contract must make the trade before the expiry. If a contract reaches maturity and expires, it can only be settled through actual delivery of the commodity or the payment of the contracted asset’s value. The initial buyers and the sellers are rarely the one to see the contract through to the maturity and often the holders of the contracts at expiry are the ones to settle the contract. After a futures contract is created it is likely to move among many parties, the finalizing parties may not even know their actual trading partners.
In case of other sureties, the initial issuer sells to the primary market, and afterwards the commodity is traded in the secondary markets, independent of the initial issuer. The security in such cases is the responsibility given to the issuer and not the buyer or the seller, and even if the some part of the sureties are bought again by the issuer, the obligation stays. Only a legitimate cancellation of the securities removes this obligation to honor payment by the issuer.
Standardization
There are infinite parameters that may define a futures contract. Therefore, the futures contracts are always regulated and are defined properly. Keeping the number of standard futures contracts to just a few is designed to makes sure that the market value of the assets stays high.
The trading exchanges are responsible for providing the platforms to trade, however the responsibility to settle or clear the trade is shouldered by other bodies. Derivative futures exchanges are responsible for quick, fair, transparent, and organized trading platforms; the clearinghouses do the final settlements of the trades. The clearinghouses are a party to the trades being carried out in the exchange.The Options Clearing Corporation (OCC) is the responsible clearinghouse for the CBOE and the London Clearing House. LCH, Clearnet is the clearing agent for LIFFE. On the other hand, The Chicago Mercantile Exchange handles the clearing part themselves, just like the ICE.
Novation and risk control
Contracts are called Derivative, when they are based on borrowed capital and their value is fluid. These contracts are more dynamic then the actual commodities. A situation known as credit risk may arise in such cases of derivative contracts where the fluctuation is great enough to incur big loss on one party even to the extent of his inability to honor the contract. The risk free trading opportunity requires assurance to the fact that payments will be honored regardless of the market position. This guarantee can only be achieved through credit assessments and trade limits on parties, thus taking away the benefits of standardized central trading facility. The clearinghouses that act as a party to futures trade assure that the trades will be honored as agreed. This practice by the clearing-houses is termed as Novation. The trading companies thus do not take risk on the real trade but only the clearing-houses. The clearinghouses employ better margining methods to reduce their own risks.
Market-to-Market and the Margin accounts
A sort of mortgage deposit called collateral is the margin offered by the owner of the commodity to cover a part or the entire credit risk involved being a counterparty to the central party, the clearing house. The types of margins demanded by the clearing-houses are the startup margin and the variation margin also called Market to Market margin. The cover deposit to cover potential future loss in the position of the financial asset is the initial margin. This margin is deposited by the company, for the clearing-house to cover for the drop in portfolio. There are many ways to calculate the initial margin.
A grid simulation used to calculate the initial margin by the CME is SPAN, which is also used by about seventy more exchanges. OCC employs a simulation based on Monte Carlo called STANS. Bursa exchange of Malaysia and some other exchanges use TIMS, which was previously used by OCC.
In order to compensate for the losses already taken by a company on the held positions, the margins collected are the Mark-to-Market Margin (MTM). The present market value and the price of the held position determine the losses to the position. When the present value is less than the cost, a loss is said to occur; this loss is covered by the company. In case of an opposite situation where the current value is more than the cost, the credit may either be deposited to the company or kept as reserve as per popular practices. The positions in both cases are market-to-market, difference between the initial cost and the current value or the new cost. The daily market-to-market positions the investors hold and the new cost figures are used to calculate the difference or the MTM.
The daily movement of the positions is transferred from the clients to the margin accounts held by the exchange, either through deduction from the account or through addition to it. In case the margin accounts depletes to a very low level, the clients have to recharge the account. This is a sure way of guaranteeing no default by the client in case of a big drop in the value of the positions held by him. As being counter-party to all trades carried out by the house, the clearing-house needs to have only a single margin account. On the other hand, an OTC Derivatives requires a negotiated settlement to all such issues like the margin accounts with the counter-party.
Regional Regulators
Normally a Government, a Governing entity or a regulatory authority appointed by the Government is tasked to regulate the futures exchanges. Regulators of some regions are:
- Australian Securities and Investments Commission – Australia
- China Securities Regulatory Commission- China.
- Securities and Futures Commission – Hong Kong.
- Securities and Exchange Board of India and Forward Markets Commission (FMC) – India.
- Financial Services Agency – Japan.
- Securities and Exchange Commission of Pakistan – Pakistan.
- Monetary Authority of Singapore – Singapore.
- Financial Services Authority – Britain.
- Commodity Futures Trading Commission – United States.
- Securities Commission Malaysia – Malaysia.
- Comisión Nacional del Mercado de Valores (CNMV) – Spain.
- Comissão de Valores Mobiliários (CVM) – Brazil.
- Financial Services Board – South Africa.
A futures exchange is the main entity where investors can buy or sell regular futures contracts; it is also called a futures market. A futures contract is a derivative agreement to buy a pre-determined number of assets or fiscal products for an agreed price at a fixed time in future. This contract is called derivative since the worth of the contract is deduced from the value of other assets involved. The price is determined through the value of the agreed commodity that may be a property or even a bond.
Evolution of Futures Trading
Politics, a book by Aristotle contains the first recorded mention of futures business. The book is a tale of a thinker named Thales from the town of Miletus, who invents a monetary instrument that is applicable all over. Thales then foresees a bumper olive produce through his talent. Having full faith in his assessment he negotiates deals granting him full rights to the olive fields at the time of harvest in future, for a low price paid now. The olive farmers unsure of the future crop yield agree to low prices and sell their future rights to Thales. Thales’ prediction turns out to be true and the olives produce is very good. Olives are increasingly demanded in the markets for extraction of oil in the presses and Thales is able to sell them for a very high price. He makes a lot of money through dictating his own rates for the olives. However, keep in mind that this type of trade is more closer to the category of an Options agreement or Contract, since it was not binding for Thales to sell the olives to the presses in case of a bad crop.
Dojima Rice Exchange located in Japan, is said to be the pioneer modern exchange for futures trade and was established in 1710.
Futures exchange in the United States of America was first established in the beginning of the 19th century. The Chicago Mercantile Exchange in the States is the biggest futures market in the world. Due to its central proximity to the most productive agricultural region in the USA, Chicago is a focal market of agricultural products. The very nature of agriculture forces fluctuations in the product prices, since less yield and increased demand increases and more yield and less demand decreases prices. The fluctuating prices led the farmers and the merchants to develop a futures trading system; an exchange empowering farmers to hedge, by agreeing to “ to arrive” and “ future paid” contracts, thus enabling them a protection from fallen prices. The C M E declared the acquirement of New York Mercantile Exchange Holdings Inc in early 2008, which materialized in August 2008. NYMEX Holdings Inc is the controlling company for NYMEX and the Futures markets.
Though these types of futures contracts were quite frequent in the past, most of them were not honored either by the seller or by the buyer. It was common for traders to go back on the contract if the price at the maturity of the contract was other than their expectations. Sometimes the seller and other times the buyer would refuse to honor the contract. Furthermore, the fluidity of a future contract market called for a meeting place for both the buyers and sellers, where they could easily find interested parties to deal with. This paved the way for traders not having to look for potential customers and rather have a proper market to do the business.
The Board of Trade in Chicago (CBOT) came to be in 1848 and the initial deals were all Forward contracts. The first recorded contract in CBOT was a trade deal in corn that was agreed on 13th march 1851. Institutionalized Forward contracts were first presented in the year 1865.
The Chicago Mercantile Exchange (CME), the newer form of the previous Egg and Butter Board, was created in 1919. Chicago Butter and Egg Board were established in 1898 and was the new name given to the Chicago Produce Exchange established in 1874. The universal standard Gold, which was adopted after the end of Second World War, was abolished in 1972 and the Chicago Mercantile Exchange developed an organ to monitor foreign currencies deals in futures contracts, named the IMM or the International Monetary Market. A few foreign currencies dealing in futures trade included; Pound, Yen, German Mark and Franc.
Local market in Minneapolis, a city in Minnesota, was established in 1881, which started futures trading in 1883. The MGEX, the Grain Exchange in Minneapolis continues to trade until today and is the lone market for the local variety of wheat futures trade in the world. This red wheat harvests in the spring season and is colored red.
The futures fiscal concept of contracts was introduced in the 70s, allowing trade in the potential worth of the interest rates. Financial futures contracts and specially the Euro-Dollar ninety-day contracts of 1981 were instrumental in the creation of the exchange market on the interest rates.
The volume of futures trade today is much more than their parent agricultural products. The introduction of the New York Market abbreviated as NYMEX has further increased the gap and the futures trade volume is many times the conventional produce trade. An increasingly significant role is being played by the futures market in the world economic system through its more than one and a half trillion US dollars daily market, by hedging and trading.
Till August 2006 the Chicago Futures Market had grown to trade seventy percent of futures contracts through its trading platform of Globex. The share of the Mercantile Exchange of Chicago is nearly fifty billion dollars daily with more than one million contracts in electronic trade, as against the manual traditional methods of trading futures, option and derivative contracts.
The Intercontinental Exchange (ICE) bought the International Petroleum Exchange (IPE) and renamed it the Intercontinental Exchange futures in mid 2001. The International Petroleum Exchange (IPE) was the biggest European open-outcry futures exchange in energy sector. ICE joined hands with the Chicago CCX in 2003 to feature its digital exchange. The energy giant ICE converted its complete energy sector futures to electronic trading system.
The first transcontinental Futures and Options Exchange was born out of the handshake between the New York Stock Exchange and the “Euronext” in 2006. Euronext already was a team comprising of major European players including Amsterdam, Brussels, Lisbon, and Paris Exchanges. The above mentioned significant events and the rapid increase of web based trading platforms for futures and options point to the possibility of futures trade being shifted to electronic platforms in entirety in the times to come.
The leading futures exchange of the world in volumetric calculations is the Indian National Stock Exchange located in Mumbai, ahead of the South African JSE Limited situated at Gauteng.
Different types of contracts
Standard regulated trades are offered by the parent exchanges. All the details regarding the identity, value and quantity of the traded commodities are recorded, as well as the timings for the trade by the futures exchanges. The currency agreed for the trade is also identified along with the minimum price of the asset, and the final possible day and month for the deal to expire. A variation from the standard commodity may well be incorporated in a futures contract to adjust the agreed price in case of a deviation from the standardized financial asset, like a second grade crop may be allowed at a lower value than the agreed standard of its first grade version.
Only an understanding exists instead of a real contract on the opening day of a startup forward contract. Unlike other sureties and bonds futures contracts are created and are not issued, whenever Open interest appreciates. In other words, futures contracts are created when a party buys a contract, on offer by the sellers. On the other hand, the created futures contracts are eliminated when the open interest depreciates; the traders sell the contracts again to decrease their long-term positions, or buy them again to reduce short-term ones.
Speculators who rely on fluctuations in potential rates and have no plans to either buy or sell at the maturity of the futures contract must make the trade before the expiry. If a contract reaches maturity and expires, it can only be settled through actual delivery of the commodity or the payment of the contracted asset’s value. The initial buyers and the sellers are rarely the one to see the contract through to the maturity and often the holders of the contracts at expiry are the ones to settle the contract. After a futures contract is created it is likely to move among many parties, the finalizing parties may not even know their actual trading partners.
In case of other sureties, the initial issuer sells to the primary market, and afterwards the commodity is traded in the secondary markets, independent of the initial issuer. The security in such cases is the responsibility given to the issuer and not the buyer or the seller, and even if the some part of the sureties are bought again by the issuer, the obligation stays. Only a legitimate cancellation of the securities removes this obligation to honor payment by the issuer.
Standardization
There are infinite parameters that may define a futures contract. Therefore, the futures contracts are always regulated and are defined properly. Keeping the number of standard futures contracts to just a few is designed to makes sure that the market value of the assets stays high.
The trading exchanges are responsible for providing the platforms to trade, however the responsibility to settle or clear the trade is shouldered by other bodies. Derivative futures exchanges are responsible for quick, fair, transparent, and organized trading platforms; the clearinghouses do the final settlements of the trades. The clearinghouses are a party to the trades being carried out in the exchange. The Options Clearing Corporation (OCC) is the responsible clearinghouse for the CBOE and the London Clearing House. LCH, Clearnet is the clearing agent for LIFFE. On the other hand, The Chicago Mercantile Exchange handles the clearing part themselves, just like the ICE.
Novation and risk control
Contracts are called Derivative, when they are based on borrowed capital and their value is fluid. These contracts are more dynamic then the actual commodities. A situation known as credit risk may arise in such cases of derivative contracts where the fluctuation is great enough to incur big loss on one party even to the extent of his inability to honor the contract. The risk free trading opportunity requires assurance to the fact that payments will be honored regardless of the market position. This guarantee can only be achieved through credit assessments and trade limits on parties, thus taking away the benefits of standardized central trading facility. The clearinghouses that act as a party to futures trade assure that the trades will be honored as agreed. This practice by the clearing-houses is termed as Novation. The trading companies thus do not take risk on the real trade but only the clearing-houses. The clearinghouses employ better margining methods to reduce their own risks.
Market-to-Market and the Margin accounts
A sort of mortgage deposit called collateral is the margin offered by the owner of the commodity to cover a part or the entire credit risk involved being a counterparty to the central party, the clearing house. The types of margins demanded by the clearing-houses are the startup margin and the variation margin also called Market to Market margin. The cover deposit to cover potential future loss in the position of the financial asset is the initial margin. This margin is deposited by the company, for the clearing-house to cover for the drop in portfolio. There are many ways to calculate the initial margin.
A grid simulation used to calculate the initial margin by the CME is SPAN, which is also used by about seventy more exchanges. OCC employs a simulation based on Monte Carlo called STANS. Bursa exchange of Malaysia and some other exchanges use TIMS, which was previously used by OCC.
In order to compensate for the losses already taken by a company on the held positions, the margins collected are the Mark-to-Market Margin (MTM). The present market value and the price of the held position determine the losses to the position. When the present value is less than the cost, a loss is said to occur; this loss is covered by the company. In case of an opposite situation where the current value is more than the cost, the credit may either be deposited to the company or kept as reserve as per popular practices. The positions in both cases are market-to-market, difference between the initial cost and the current value or the new cost. The daily market-to-market positions the investors hold and the new cost figures are used to calculate the difference or the MTM.
The daily movement of the positions is transferred from the clients to the margin accounts held by the exchange, either through deduction from the account or through addition to it. In case the margin accounts depletes to a very low level, the clients have to recharge the account. This is a sure way of guaranteeing no default by the client in case of a big drop in the value of the positions held by him. As being counter-party to all trades carried out by the house, the clearing-house needs to have only a single margin account. On the other hand, an OTC Derivatives requires a negotiated settlement to all such issues like the margin accounts with the counter-party.
Regional Regulators
Normally a Government, a Governing entity or a regulatory authority appointed by the Government is tasked to regulate the futures exchanges. Regulators of some regions are:
Australian Securities and Investments Commission – Australia
China Securities Regulatory Commission- China.
Securities and Futures Commission – Hong Kong.
Securities and Exchange Board of India and Forward Markets Commission (FMC) –India.
Financial Services Agency–Japan.
Securities and Exchange Commission of Pakistan – Pakistan.
Monetary Authority of Singapore – Singapore.
Financial Services Authority–Britain.
Commodity Futures Trading Commission–United States.
Securities Commission Malaysia – Malaysia.
Comisión Nacional del Mercado de Valores (CNMV) –Spain.
Comissão de Valores Mobiliários (CVM) –Brazil.
Financial Services Board – South Africa.