Futures Contract

Margin requirements are waived or reduced in some cases for hedgers who have physical ownership of the covered commodity or offsetting contracts for its purchase or sale.

Initial margin is paid by both buyer and seller. It represents the loss on that contract, as determined by historical price changes, that is not likely to be exceeded on a usual day's trading.

Because a series of adverse price changes may exhaust the initial margin, a further margin, usually called variation margin, is called by the exchange. This is calculated by the futures contract, i.e. agreeing a price at the end of each day, called the "settlement" or mark-to-market price of the contract.

Margin-equity ratio is a term used by speculators, repesenting the amount of their trading capital that is being held as margin at any particular time. Traders would rarely (and unadvisedly) hold 100% of their capital as marign. The probability of losing their entire capital at some point would be high. By contrast, if margin-equity so low as to make the trader's capital equal to the value of the futures contract itself, not profit from the inherent leverage implicit in futures trading. A conservative trader might margin-equity at 15%, a more aggressive trader at 40%.

• Cash delivery, settling against an agreed reference rate such as the closing value of a stock index, or of an interest index such as LIBOR.
• Physical delivery . where the amount specified of the underlying asset of the contract is delivered by a seller of the contract to the exchange, and by the exchange to buyers of the contract. Physical delivery is more common with commodities, though is also used for financial instruments such as bonds.

F(t) = S(t)*(1+r)^(T-t) or, with continuous compounding F(t) = S(t)e^r(T-t)

This relationship may be modified for storage costs, dividends, dividend yields, and convenience yields.

In a perfect market the relationship between futures and spot prices depends only on the above variables; in practice there are various market imperfections (transaction costs, differential borrowing and lending rates, restrictions on short selling) that prevent complete arbitrage. Thus, the futures price in fact varies within arbitrage boundaries around the theoretical price.

see:

Futures contracts and exchanges

• Foreign exchange market
• Money market
• Bond market
• Equity index market
• Base metals market
• Precious metals market
• Energy market
• Soft Commodities market

• London International Financial Futures Exchange (LIFFE)
• London Commodity Exchange - 'softs', grains and meats. Inactive market in Baltic Exchange shipping.
• London Metal Exchange - metals, mainly copper, aluminium, lead, zinc, nickel and tin.
• International Petroleum Exchange - energy including crude oil, heating oil, natural gas and unleaded gas.
• Chicago Board of Trade (CBOT) -- financials (bonds), traditional commodities: maize, oats, rough rice, soybeans, soybean meal, soybean oil, wheat,
• Chicago Mercantile Exchange -- financial futures, traditional commodities: lumber, live cattle, feeder cattle, boneless beef, boneless beef trimmings, lean hogs, frozen pork bellies, fresh pork bellies, Basic Formula Price milk, butter,
• New York Board of Trade - Softs : cocoa, coffee, cotton, orange juice, sugar
• New York Mercantile Exchange - Energy and metals: crude oil, gasoline, heating oil, natural gas, coal, propane, gold, silver, platinum, copper, aluminum and palladium

Who trades futures?

Hedgers typically include producers and consumers of a commodity.

For example, in traditional commodities markets farmers often sell futures for the crops and livestock they produce to guarantee a certain price, making it easier for them to plan. Similarly, livestock producers often purchase futures to cover their feed costs, so that they can plan on a fixed cost for feed. In modern (financial) markets, "producers" of interest rate swaps or equity derivative products will use financial futures or equity index futures to reduce or remove the risk on the swap.

The social utility of futures markets is considered to be mainly in the transfer of risk between traders with different risk preferences, from a hedger to a speculator for example.

• Agriculture
• Commodity markets

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