Futures Derivatives

• Futures contracts are traded on an organize exchange, and the contract terms are standardized by that exchange
• The vast majority of futures contracts do not lead to delivery because 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
• For most contracts, daily price movement limits are specified by the exchange. Normally, trading ceases for the day once the contract is limit up or limit down
• 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
• A limit move is a move in either direction equal to the daily price limit
• As the delivery period for a futures contract is approaching, the futures prices 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
• This is because of arbitrage opportunity: Sell a futures contract, Buy the asset, Make delivery
• The amount that must be deposited at the time the contract is entered into is known as the initial margin
• To ensure that the balance in the margin account never becomes negative, a maintenance margin, which is somewhat lower than the initial margin, is set. It is usually about 75% of the initial margin
• If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level the nest day
• The extra funds deposited are known as variation margin
• In an attempt to reduce credit risk, the over-the-counter market is now imitating the margining system adopted by exchanges with a procedure known as collateralization
• Open Interest is the total number of contracts that is outstanding
• Types of trades and orders:

1. limit order
2. stop-loss order
3. stop-limit order
4. market-if-touched order
5. market-not-held order