What are futures?

Introducing Futures

Most readers of this blog must have come across, one way or another, the concept of futures. However, it is one thing to come across and present this financial instrument only in general terms, and it is another thing to trade futures or with the help of information received from this forward contract market. As an example of a trading system, which is based on the concept of futures and margin requirements, we can call trading on margin zones.

To begin with, let’s figure out what a futures contract is all about.

The official full definition can be read on the Wikipedia website.

It will be much more convenient for us to operate the compact versions in order to understand the essence:

Futures (from the English “ future ” – the future) is a standardized exchange forward contract, which involves bilateral participation in the transaction on the underlying asset.

We highlight the keywords: exchange, standardized, forward. We will reveal these concepts. Futures, first of all, are traded on the exchange platform, so the contracts are fully and as standardized as possible. Players are offered certain conditions both in terms of the underlying asset and in terms of delivery, expiration date, and price. These conditions are one for all and are in the public domain. Anyone can get acquainted with them. After each closed trading session, the exchange publishes reports, analyzing which, you can double-check the actions of the exchange itself. Forward – this means that the execution of the contract will occur in the future at a predetermined price. As we see, quite favorable and convenient conditions are created for all market participants.

A small remark: when I talk about futures, I primarily mean contracts that are traded on the American exchange CME Group. Why? – Because most FOREX traders are interested in currency futures, futures for gold, oil, gas, indices and the like; and CME is the largest currency and commodity futures market in the world.

Futures is one of the liquid financial instruments that allow you to buy/sell goods in the future at a predetermined price today.

Futures are primarily used for hedging, and secondly, for speculation.

Futures characteristics

For each underlying asset, the terms of futures trading will differ, although there will be some similarity in one group of instruments (currencies, metals, different types of oil, indices, etc.).

Each future has characteristics:

  • title
  • validity
  • quantity of goods/currency in the contract
  • minimum price fluctuation
  • cost of one item
  • margin requirements
  • product code (ticker)
  • Contract listing procedure (quarterly, monthly)
  • calculation method
  • trading schedule

Since the transaction is bilateral, you can participate on the side of the buyer or seller, but in each contract on the market, there are always two parties.

Futures Margin Requirements

When we talk about margin requirements for futures, the first thing we need to figure out is what margin is in general and what types (types) of margin are on the forward contract market.

Margin Initial – Initiating

In some sources, the name “original ” is found. This is the amount that allows a market participant to open a transaction (purchase or sale). This is not a loan or a loan and not partial payment of an asset. This is a guarantee of your solvency for the exchange.

If there is no money for the initial margin, you will not be able to open a futures position.

So, suppose we have $ 4,000 in our trading account. You want to buy Euro futures at the price of 1.1160. The initial margin is currently $ 2,200 per contract. Accordingly, when you make a deal with one contract, $ 2200 is blocked in your account. Further, if you continue to hold the transaction, the accumulated profit is added to this amount if the price rises or dollars are taken away if the price falls.

In other words, the initiating margin is a certain amount of money that the exchange wants to see on your working account on the day you open the position (on the first clearing), multiplied by the number of open contracts. In our example, the balance of available funds becomes equal to 4000 – 2200 = 1800.

Maintenance Margin – Supporting.

If the duration of your trading position exceeds the scope of the second trading session, then from the second clearing transfer the maintenance margin, which is usually less than the initiating margin by a certain percentage value, takes over.

Let’s go back to the example with our EUR futures deal. Suppose that we decided to transfer our position to the third trading session. From the date of transfer, a maintenance margin is applied to our position, which at the moment is $ 2000.

We opened a purchase at a price of 1.1160. For some time, the price fell by 50 points. At the time of the second clearing transfer, the futures price was at the level of 1.1110. Therefore, we received a loss of 50 * 12.5 (value of a point) = $ 625. Our deposit has become equal to 4000 – 625 = 3375, which is still more than $ 2000, therefore such a drop in the euro is not scary for maintaining and prolonging the position.

The value of a point is the amount in currency by which the trader’s deposit changes depending on the increase or decrease in the price of one point. The value can be found in the instrument specification on the official website of the exchange/broker.

The next day the price fell again, this time from the level of 1.1110 to the level of 1.0990. The loss amounted to 120 p. (Or 120 * 12.5 = $ 1,500). Our deposit after clearing turned out to be equal to $ 1875. This is already less than the supporting margin, so we are expecting Futures Margin Call from the exchange?

Fut. Margin Call – a letter from a broker or exchange with a proposal to deposit the missing funds up to the maintenance margin to the trading account within three days. Otherwise, futures that do not meet the conditions will be forcibly closed on the market.

In case of receiving the Futures Margin Call, the trader can:

  1. Increase the amount of capital in the account, release funds from other positions;
  2. Close all or part of a futures position;
  3. Just do nothing, thinking that everything will pass by itself if you pray to the god of the market.

Intraday or Intra-Session Margin

This type of margin is set exclusively by the broker for those traders who want to trade intraday, i.e. will not transfer their positions through clearing. It is usually much less supportive and makes up about 10% of it. Although the conditions for different companies may be different.

The intraday margin is valid throughout the trading session until the last minute. Working on such a margin, the trader agrees to independently close positions before clearing, otherwise, his transactions will be forcibly closed by the broker due to the mismatch of the deposit to the size of the supporting margin.

Basically, traders with little money work on this type of margin collateral. They are unable to transfer positions the next day, and they also do not earn on gaps.

When does the margin return to the account?

  1. In case of an offset transaction
  2. In the event of forced closure of a position by a broker/exchange, net of uncovered losses from the free funds of the trader.

Offset transaction is a transaction opposite to the original position. For the buyer, the offset transaction will be a sale. For the seller, a purchase. When making an offset transaction, no margin will be charged.

In this article, we looked at basic concepts related to financial instruments such as futures. In subsequent publications, we will delve into this topic and consider the practical value of this information for us, as for forex traders.