Trading Platforms and Global Markets

Unit - II
What are we going to learn?

• Futures Markets
• Future Contracts
• Futures Exchanges
• Clearing and Margin Mechanism
• Trading Setup (RM, Traders, Dealers, Clients)
• Bonds Dealing
• Nomenclature of Bonds
• Bond order entry
• YTM
• Coupon Calculations
• Schedules
Futures Market
What is the need?

Sell Buy

Will Have Will Need

Futures Market
100 Kg Potatoes 100 Kg Potatoes
Jan 24 Jan 24
Futures Contract
What is the need?

A contract for assets (especially commodities or shares) bought at agreed prices but delivered and paid for later.

Characteristics of Futures Contract

1. Standardization: Futures contracts are highly standardized, specifying key elements such as the underlying asset, contract
size, expiration date, and delivery arrangements. This standardization ensures that all contracts of a particular type are
identical, simplifying trading and reducing transaction costs.
2. Leverage: Traders can control a large position with a relatively small initial investment, known as the initial margin. This
amplifies both potential profits and potential losses, making futures trading a double-edged sword that requires careful risk
management.
3. Hedging: Futures contracts serve as effective tools for risk management. Hedgers use them to protect against adverse price
movements in the underlying asset. For example, a farmer can use grain futures to lock in a future selling price, safeguarding
against price declines.
Futures Contract
What is the need?

Characteristics of Futures Contract

4. Price Discovery: Futures markets are known for their role in price discovery. The futures prices established through market
forces reflect market sentiment and expectations about future asset prices. These prices are widely followed as benchmarks for
the underlying asset's value.
5. Liquidity: Futures markets are generally highly liquid, providing traders with ample opportunities to enter and exit positions.
This liquidity is due to the standardized nature of contracts and the participation of various market players, including
speculators and institutional investors.
6. Margin Requirements: Futures contracts require traders to deposit an initial margin to initiate a position and maintain a
maintenance margin to keep the position open. Margin requirements help ensure that traders have the financial capacity to
fulfill their contractual obligations.
7. Mark-to-Market: Futures contracts are marked to market daily, meaning that the gains and losses on positions are settled
daily. This process keeps traders accountable and ensures that margin requirements are met.
 Futures Contract
What is the need?

Characteristics of Futures Contract

8. Diverse Underlying Assets: Futures contracts are available on a wide array of underlying assets, including commodities
(e.g., oil, gold), financial instruments (e.g., stock indices, interest rates), and even non-traditional assets (e.g., weather
conditions, cryptocurrencies).
9. Flexibility: Futures contracts offer flexibility in terms of trading strategies. Traders can take both long (buy) and short
(sell) positions, engage in spread trading, and use options on futures for more complex strategies.
10. Exchange-Traded: Futures contracts are typically traded on regulated exchanges, ensuring transparency, market integrity,
and standardized contract terms. Exchange rules and clearing mechanisms provide a level of protection to market
participants.
Futures Contract
What are the types?

Futures contracts can be used to set prices on any type of commodity or asset, so long as there is a sufficiently large market for it.
Some of the most frequently traded types of futures are outlined below:

• Agricultural Futures: These were the original futures contracts available at markets like the Chicago Mercantile Exchange. In
addition to grain futures, there are also tradable futures contracts in fibers (such as cotton), lumber, milk, coffee, sugar, and even
livestock.
• Energy Futures: These provide exposure to the most common fuels and energy products, such as crude oil and natural gas.
• Metal Futures: These contracts trade in industrial metals, such as gold, steel, and copper.
• Currency Futures: These contracts provide exposure to changes in the exchange rates and interest rates of different national
currencies.
• Financial Futures: Contracts that trade in the future value of a security or index. For example, there are futures for the indexes
like Bank Nifty. There are also futures for debt products, such as Treasury bonds
Futures Contract
What are the different parameters?

Specifications of Future Contract

1. Asset
• The asset, often referred to simply as the "underlying," is the fundamental component of a futures contract.
• It is the asset on which the futures contract derives its value and represents what the contract obligates the parties to buy or sell
in the future.
• The choice of the underlying asset depends on the specific futures contract and the market it serves.
• Underlying assets can vary widely and include commodities (e.g., crude oil, gold, wheat), financial instruments (e.g., stock
indices, interest rates), and even non-traditional assets like weather conditions or cryptocurrencies.
• The financial assets in Futures Contracts are generally well defined and no specification is required
• In case of commodity there might be quite a variation in the quality of what is available in the marketplace
• Commodity futures exchange specifies the acceptable grade(s) of the commodity
• For some cases a range of grades can be delivered, but the price received depends on the grades chosen. In that case price is
adjusted in a way established by the exchange.
Futures Contract
What are the different parameters?

2. Contract Size
• Contract size, also known as the "lot size" or "notional value," specifies the quantity of the underlying asset that the futures
contract represents.
• It determines the scale of the contract and how much of the asset will be delivered or received upon contract expiration.
• Contract sizes vary widely based on the asset class and the exchange on which the contract is traded.
• For instance, a standard gold futures contract may represent 100 troy ounces of gold, while a stock index futures contract might
represent a certain dollar amount of the index.

Why contract size is important?

• This is an important decision for the exchange.
• If the contract size is too large, many investors who wish to hedge relatively small exposures or who wish to take relatively
small speculative positions will be unable to use the exchange.
• On the other hand, if the contract size is too small, trading may be expensive as there is a cost associated with each contract
traded.
Futures Contract
What are the different parameters?

3. Price Quotes
• Price quotes in futures contracts refer to the ongoing market prices at which buyers and sellers are willing to transact.
• These quotes provide essential information to traders, allowing them to assess the current market conditions, make trading
decisions, and execute trades.
• The exchange defines how prices will be quoted.
• For example, in the US crude oil futures contract, prices are quoted in dollars and cents. Treasury bond and Treasury note
futures prices are quoted in dollars and thirty-seconds of a dollar.

4. Price Limits and Position Limits

• For most contracts, daily price movement limits are specified by the exchange.
• If in a day the price moves down from the previous day’s close by an amount equal to the daily price limit, the contract is said
to be limit down. If it moves up by the limit, it is said to be limit up.
• Position limits are the maximum number of contracts that a speculator may hold.

What is the Purpose?

• The purpose of daily price limits is to prevent large price movements from occurring because of speculative excesses. However,
limits can become an artificial barrier to trading when the price of the underlying commodity is advancing or declining rapidly.
• The purpose of these position limit is to prevent speculators from exercising undue influence on the market.
Futures Contract
What are the different parameters?

Specifications of Future Contract

5. Delivery Month
• A futures contract is referred to by its delivery month. E.g.
• The exchange must specify the precise period during the month when delivery can be made.
• For many futures contracts, the delivery period is the whole month.
• Exchanges specifies when trading in a particular month’s contract will begin. The exchange also specifies the last day on which
trading can take place for a given contract. Trading generally ceases a few days before the last day on which delivery can be
made.

6. Delivery Arrangements
• Futures contracts typically specify how and when the delivery of the underlying asset will occur if the contract is held until its
expiration.
• For contracts that involve physical delivery, details such as the delivery location, quality standards, and delivery month are
specified to ensure a smooth transfer of the asset from the seller to the buyer.
• Not all futures contracts result in physical delivery; many are cash-settled, meaning that the difference between the contract
price and the market price at expiration is settled in cash.
Futures Contract
What are the different parameters?

Specifications of Future Contract

Closing Out Positions:

• The vast majority of futures contracts do not lead to delivery.

• The reason is that most futures contracts are actively traded speculatively or for hedging.
• Hence, most traders choose to close out their positions prior to the delivery period specified in the contract.
• Closing out a position means entering into the opposite trade to the original one.
• Delivery is so unusual that traders sometimes forget how the delivery process works.
Futures Contract
How the price changes?

Convergence of Future Price to Spot Price

As the delivery period for a futures contract is approached, the futures price converges to the spot price of the underlying asset.
When the delivery period is reached, the futures price equals—or is very close to—the spot price.

Why?
we first suppose that the futures price is above the spot price during the delivery period.
• Traders then have a clear arbitrage opportunity
1. Sell (i.e., short) a futures contract
2. Buy the asset
3. Make delivery.
• These steps are certain to lead to a profit equal to the amount by which the futures price exceeds the spot price.
• As traders exploit this arbitrage opportunity, the futures price will fall.

Suppose next that the futures price is below the spot price during the delivery period.
• Companies interested in acquiring the asset will find it attractive to enter into a long futures contract and then wait for delivery
to be made.
• As they do so, the futures price will tend to rise.
Futures Contract
How the price changes?

Convergence of Future Price to Spot Price

 Futures Contract
How the contract works?

Margins
Margins are a critical component of futures trading and are used to ensure that traders have the financial resources to fulfill their
contractual obligations. They are deposits held with the broker to cover potential losses that may occur during the life of a futures
contract.

Why Margins are used?

The use of margin in futures trading serves several essential purposes, and it's a fundamental aspect of maintaining the integrity
and stability of futures markets. Here are the key reasons why margin is necessary in futures trading:

1. Risk Mitigation:
• Futures contracts are highly leveraged, meaning that a trader can control a large position with a relatively small amount of
capital.
• This leverage amplifies both potential profits and potential losses.
• Margin acts as a safeguard by ensuring that traders have enough funds to cover potential losses.
• It helps protect the financial stability of traders and reduces the risk of default on contract obligations.
Futures Contract
How the contract works?

Why Margins are used?

2. Market Integrity:
• Without margin, traders could potentially take on positions that far exceed their financial capacity, leading to significant market
disruptions if they were unable to meet their obligations.
• Margin requirements encourage responsible trading practices and discourage excessive speculation.

3. Daily Settlement:
• Futures contracts are marked to market daily, which means that the gains and losses on positions are settled daily.
• This ensures that traders meet their obligations in real-time as market prices change.
• Margin funds are used to cover these daily settlement variations.
• This daily settlement process helps prevent the accumulation of large losses that could be difficult to cover if allowed to
accumulate over time.
Futures Contract
What are the types?

1. Initial Margin:
• The initial margin, also known as the "performance bond" or "original margin," is the initial amount of money a trader must deposit with their
broker to establish a futures position.
• It ensures that traders have sufficient capital to meet potential losses and obligations from their positions. Initial margin requirements vary by
contract and exchange and are typically set as a percentage of the contract's notional value.
• Before initiating a futures position, a trader must deposit the required initial margin with their broker. This margin serves as a "good faith"
deposit.
2. Maintenance Margin:
• Maintenance margin is the minimum amount of capital that must be maintained in a trading account to keep a futures position open.
• It helps ensure that traders can cover ongoing losses that may occur as market prices fluctuate. If the account balance falls below the
maintenance margin level, a margin call is issued.
• After opening a futures position, traders must maintain their account balance above the maintenance margin requirement. If the account balance
falls below this level, a margin call is triggered.
3. Variation Margin:
• Variation margin, also known as "daily settlement variation," is the amount of money added to or subtracted from a trader's account on a daily
basis to account for price fluctuations.
• It ensures that traders meet their obligations in real-time as market prices change. Gains and losses are settled daily.
• At the end of each trading day, the exchange calculates the daily profit or loss for each futures position, and the corresponding variation margin
is added or subtracted from the trader's account.
Thank You