Basics Of Futures Trading

Trading futures brings people together to transfer the price risk associated with the ownership of some commodity, like wheat, or a service, like an interest rate or index. No property rights to a physical commodity change hands at the time the futures contract is entered into.

A futures contract is a form of forward contract, a contract to buy or sell an asset of any kind at a pre-agreed future point in time, that has been standardized for a wide range of uses. It is traded on a futures exchange

The standardization usually involves specifying:

  1. The amount and units of the underlying asset to be traded. This can be a fixed number of: Equity index points; units of foreign currency; National bonds
  2. The unit of currency in which the asset is quoted. Because U.S. futures exchanges have dominated the market, this is very often the US dollar (USD), even when the corresponding OTC market quotes differently (for example the Interbank market quotes in yen per USD, whereas currency futures are quoted in USD per yen).
  3. The grade of the deliverable. In the case of physical commodities, this specifies not only the quality of the underlying goods but also the manner and location of delivery. For example, the NYMEX Light Sweet Crude Oil contract specifies the acceptable sulfur content and API specific gravity, as well as the location where delivery must be made.
  4. The delivery month: For futures contracts specifying physical delivery, the delivery month is the month in which the seller must deliver, and the buyer must accept and pay for, the underlying. For contracts specifying cash settlement, the delivery month is the month of a final mark-to-market(mark to market is the act of assigning a value to a position held in a tradable financial instrument based on the current market price for that instrument) The exact dates of acceptable delivery vary considerably and will be specified by the exchange in the contract specifications. For most futures contracts, at any given time, one contract will typically traded much more actively than others. This is called variously the front month or the top step contract .Financial contracts (such as bonds, short term interest rates, foreign exchange and stock indexes) tend to expire quarterly, in March, June, September and December.

    This table lists the conventional letter codes used in tickers to specify delivery month:

January F April J July N October V
February G May K August Q November X
March H June M September U December Z

 

The last trading date: Every futures contract has a last trade date and a delivery period specified by the exchange. In the case of a cash settled future, the delivery period is the last trade date. On that date, the settlement price is set equal to the cash price of the underlier. There is a final margining based on that settlement price, and then the contract expires.

Floor Trading & Electronic Trading (globex)

CME and most other U.S. futures exchanges offer two venues for trading: the traditional floor-trading venue and electronic trading. Broadly speaking, trading is essentially the same in either format: Customers submit orders that are executed – filled – by other traders who take equal but opposite positions, selling at prices at which other customers buy or buying at prices at which other customers sell. This matching of buyers and sellers occurs in both open outcry and electronic trading, but there are some differences between the two processes.

In open outcry trading, orders are communicated to brokers in a trading pit, via requests that customers make to their brokerages by phone or computer. Customer bids and offers are presented by pit brokers to other brokers standing in the pit, and trades are “executed” – matches are made – when prices that are mutually acceptable to buyers and sellers are identified. Customers are notified of their trades, information about each trade is sent to the clearinghouse and brokerages, and prices are disseminated immediately throughout the world. The trade order is also time-stamped at both ends of the process.

In electronic or screen-based trading, customers send buy or sell orders directly from their computers to an electronic marketplace offered by the exchange. There is no need to have brokers submit and execute orders for customers, because the customers will have received brokerage approval to trade electronically, and the exchange computer system informs the brokerages of customer activity. In a sense, the trading screen replaces the trading pit, and the electronic market participants replace the brokers standing in the pit. The exchange computer system keeps track of all trading activity, and identifies matches of bids and offers, with fills generally made according to a first-in, first-out (FIFO) process, although some alternate allocation processes are used in particular markets. Trade information is sent to the clearinghouse and brokerage, and prices are also instantaneously broadcast to the public. Trades made on CME Globex®, for instance, are typically completed in a fraction of a second. In open outcry trading, however, it can take from a few seconds to minutes to execute a trade, according to the complexity of the order.

A system for global after hours electronic trading in futures and options developed by Reuters for CME and CBOT for use in conjunction with various exchanges round the world. Globex was launched on June 25, 1992, for certain CME contracts. An electronic trading platform used for derivative, futures, and commodity contracts. Globex runs continuously, so it is not restricted by borders or time zones.

Today, trading on GLOBEX is conducted virtually around the clock, five days a week, and traders from around the world are active participants. With average daily volume exceeding one million contracts, GLOBEX is one of the largest electronic derivatives markets in existence.

GLOBEX offers access to all four of the CME’s major product categories — equities, interest rates, foreign exchange, and commodities. In addition, GLOBEX also offers certain trading products in collaboration with other exchanges. Some products are offered exclusively on GLOBEX, some trade side-by-side on the CME trading floor and GLOBEX during the trading day, and a few trade only after open-outcry trading hours.

The most popular futures contracts that trade on the GLOBEX system are, by far, E-mini stock index futures. The CME is the world’s largest exchange for trading stock index futures, with 95% of the market share in U.S. stock index futures.

All E-mini futures are fully electronic and trade exclusively on GLOBEX, so they’re perfectly suited to online traders who value transparent prices, instant execution, and low costs. E-mini stock index futures are also appealing because of their excellent liquidity, around-the-clock trading hours (E-minis trade nearly continuously, 24 hours per day), and manageable size (one-fifth the size of standard stock index futures contracts). For all these reasons, the products in the E-mini futures complex are among the fastest growing products the CME has ever launched.