Closing futures positions:

· Offset {buy a contract to close a short position and sell a contract to close a long position, most common}.
· Delivery {any contract outstanding at expiration settled by physical delivery of asset, less than 1% of settlement use this method.
· Cash settlement {many financial futures do not allow physical delivery and instead require cash settlement}.
· Exchange for physicals (EFP) {two traders with opposite side of a contract conduct the transaction and ask exchange to cancel their positions, different from delivery:

• actually exchange goods
• contract not closed
• 2 traders privately negotiated

Future markets

· Futures buyer has a long position on underlying asset.
· Futures seller has a short position.
· Futures buyer profits if asset price rises, while futures seller profits if asset price falls.

Futures contracts is standardized by the quality of the underlying asset, notional amount, tick size {smallest unit by which futures price can change}, tick value {dollar value of one tick}, expiration, delivery terms, and margin requirements.

---- standardized contract terms => uniformity promote market liquidity
---- Clearing house =>never default, split all trades & acts as counterparties.

Benefits of futures:
· Price discovery (by creating a highly liquid and transparent market)
· Hedging. Regulation and speculation are required for smooth functioning of futures market, but are not considered to be benefits.

Hedging:
· To reduce a long exposure {e.g. investor holding a stock portfolio, firm mining gold, farmer with wheat in the field}, you would sell futures.
· To reduce a short exposure {e.g. airline that needs to buy oil, importer who needs to buy foreign currency}, you would buy futures.

Speculation:
· If you believe prices will rise buy futures. If you think they will fall, sell futures.

Open interest = Outstanding long positions + Outstanding short positions
· open interest refers to the no. of contracts that currently in existence
eg. open interest of 100-> 100 short positions & 100 long positions.

Trading volume
· Activity measured by trading volume:
· Number of contracts executed in a given day.
· When a party buys a future it generates one unit of trading volume.
· If the party then closes out by selling the contract, it generates another unit of trading volume.

Margin & Daily settlement
· can be posted in cash, bank letter of credit, or treasury bills

Initial margin:
· Amount that must be deposited at the time of opening a futures position.

Maintenance margin:
· Level to which a margin account may fall before a request for additional funds (a margin call) is made.

Variation margin = Initial margin - Equity balance in margin account
· Must be deposited upon the receipt of a margin call to bring the margin account back to the required level.

Types of contract:
· agricultural & metallurgical contracts
· interest bearing assets (interest rate future)
· foreign exchange, Indexes

In physical,metal is most active contract; In all contract types, financial instruments is most spectacular groth, more than 50% of all trading volume.

Futures versus forwards

Forwards:
· Negotiated privately in the OTC market,
· Customized
· Do not have any margin requirements
· Expose the parties to credit risk.
· Require no cash transaction until delivery date, usually not regulated

Futures:
· Standardized, exchange-traded contracts
· More liquid and so cheaper than forwards
· Buyers and sellers must deposit a margin with the exchange/clearing house
· Near-zero credit risk
· Regulated