Futures and Forwards

Futures and Forwards

Futures and Forwards Basics

Futures

Definition:
Futures contracts are standardized agreements to buy or sell an asset at a predetermined price at a specified future date.
Features:
  1. Standardization: The terms (such as quantity, quality, delivery date) are standardized by the exchange.
  1. Trading Venue: Traded on exchanges like the Chicago Mercantile Exchange (CME).
  1. Margin Requirement: Requires margin deposits, with margins adjusted by the exchange based on market volatility.
  1. Daily Settlement: Gains and losses are settled daily, a process known as "mark-to-market."
  1. Liquidity: Typically high due to standardization.
  1. Delivery: Most contracts are settled in cash; some involve physical delivery.
Common Interview Questions and Answers:
  • Standardization: Futures contracts are standardized by the exchange.
  • Trading Mechanism: Futures are traded on exchanges, require margins, and are marked to market daily.
  • Purpose: Used for hedging or speculation.

Forwards

Definition:
Forward contracts are customized agreements between two parties to buy or sell an asset at a specified price on a future date.
Features:
  1. Customization: Terms are negotiated and customized by the parties involved.
  1. Trading Venue: Traded over-the-counter (OTC), not on an exchange.
  1. Credit Risk: Higher credit risk due to the lack of an intermediary.
  1. Settlement: Settlement occurs at the contract's maturity.
  1. Liquidity: Typically lower due to customization.
Common Interview Questions and Answers:
  • Customization: Forward contracts are customized agreements.
  • Credit Risk: Higher credit risk due to OTC trading.
  • Purpose: Used for hedging, especially for specific needs.

Main Differences

1. Standardization:
  • Futures: Standardized by the exchange.
  • Forwards: Customized by the parties.
2. Trading Venue:
  • Futures: Traded on exchanges.
  • Forwards: Traded OTC.
3. Margin System:
  • Futures: Requires margins and daily settlement.
  • Forwards: Typically no margin requirement.
4. Settlement:
  • Futures: Daily settlement (mark-to-market).
  • Forwards: Settlement at maturity.
5. Liquidity:
  • Futures: High liquidity.
  • Forwards: Lower liquidity.

Netting via Central Counterparty (CCP)

Definition:
Netting via a Central Counterparty involves aggregating multiple financial transactions between counterparties and calculating a single net obligation for each party. This process significantly reduces the number of transactions and the associated risk.
Key Features:
  1. Centralized Clearing: CCP acts as an intermediary between buyers and sellers, becoming the buyer to every seller and the seller to every buyer.
  1. Risk Reduction: By netting multiple transactions, the CCP reduces counterparty risk and the overall systemic risk in the market.
  1. Margin Requirements: CCPs typically require initial and variation margins from participants to cover potential losses.
  1. Default Management: CCPs have mechanisms in place to manage defaults by any of the participants, ensuring the stability of the clearing system.
  1. Regulatory Oversight: CCPs are subject to strict regulatory oversight to ensure their robustness and ability to manage risks effectively.
Process:
  1. Trade Execution: Parties execute trades, which are then submitted to the CCP for clearing.
  1. Position Netting: The CCP nets the positions of each participant, calculating the net exposure.
  1. Margin Collection: The CCP collects margins to cover potential default risks.
  1. Settlement: The CCP facilitates the settlement of netted positions, reducing the number of transactions and the amount of capital required.
Example Scenario
Scenario:
Two banks, A and B, engage in multiple derivative transactions over a period. Instead of settling each transaction individually, the CCP nets the positions.
  • Without CCP Netting:
    • Bank A owes Bank B $10 million.
    • Bank B owes Bank A $8 million.
    • Two separate settlements totaling $18 million.
  • With CCP Netting:
    • The CCP nets the positions.
    • Bank A owes the CCP $2 million.
    • Bank B is owed $2 million by the CCP.
    • Only one settlement of $2 million.
        • notion image
 

Pricing Future contracts

Convergence

notion image
 

Pricing future example

notion image
notion image
notion image
notion image
 
notion image
 

Major Commodity Futures Categories

Commodity futures are contracts to buy or sell specific quantities of a commodity at a predetermined price at a specified time in the future. These contracts are standardized and traded on exchanges, providing a way to hedge against price fluctuations or speculate on price movements. Major commodity futures categories include:

1. Agricultural Commodities

  • Grains and Oilseeds: Includes futures for wheat, corn, soybeans, and canola.
  • Soft Commodities: Includes futures for coffee, cocoa, sugar, and cotton.
  • Livestock: Includes futures for live cattle, feeder cattle, and lean hogs.
Example:
  • Corn Futures: Traders may use corn futures to hedge against or speculate on price changes in corn, which is a staple in food production and animal feed.

2. Energy Commodities

  • Crude Oil: Includes futures for West Texas Intermediate (WTI) and Brent crude oil.
  • Natural Gas: Futures for natural gas, a key energy source for heating and electricity.
  • Refined Products: Includes futures for gasoline and heating oil.
Example:
  • Crude Oil Futures: Used by producers and consumers of oil to hedge against price volatility, and by speculators looking to profit from price changes.

3. Metals

  • Precious Metals: Includes futures for gold, silver, platinum, and palladium.
  • Base Metals: Includes futures for copper, aluminum, nickel, and zinc.
Example:
  • Gold Futures: Popular among investors as a hedge against inflation and currency fluctuations, and also used by jewelers and manufacturers.

4. Financial Futures

  • Interest Rate Futures: Includes futures on government bonds, Eurodollar futures, and Treasury bills.
  • Currency Futures: Futures contracts on major currencies like the USD, EUR, JPY, and GBP.
  • Stock Index Futures: Futures on major stock indices like the S&P 500, NASDAQ, and Dow Jones Industrial Average.
Example:
  • S&P 500 Futures: Used by investors to hedge against or speculate on movements in the stock market.

5. Environmental Commodities

  • Carbon Emissions: Includes futures for carbon credits, used in cap-and-trade systems to control pollution.
  • Renewable Energy Certificates (RECs): Futures for certificates representing proof that energy has been generated from renewable sources.
Example:
  • Carbon Emissions Futures: Used by companies to manage their carbon footprint and comply with regulatory requirements.

Futures hedge ratio

notion image
 

Forwards

双方约定：在未来某一天，以今天约好的价格，买或卖某个资产。
  • 有 义务（不是选择）
  • 到期必须执行
  • 不用先付钱（通常）

Forward 的核心特征（考试 / 面试高频）

特征
你要记住
是否有义务
✅ 必须履约
初始成本
通常 0
风险
无限盈利 / 无限亏损
收益形态
线性（直线）
主要用途
对冲（hedging）

Long / Short Forward（一定要会）

🔹 Long Forward（买远期）

  • 未来 买
  • 标的涨 → 赚钱
  • 标的跌 → 亏钱
📈 收益：一直向上的直线

🔹 Short Forward（卖远期）

  • 未来 卖
  • 标的跌 → 赚钱
  • 标的涨 → 亏钱（无限）
📉 收益：一直向下的直线

Forward 最重要的用途（这一点很关键）

用来“锁价格 / 锁风险”
经典例子：
  • 你有股票 → 怕短期下跌
      • 👉 卖出指数 forward
      👉 股票跌了你亏，但 forward 赚钱
      👉 总资产被“锁住”
📌 Forward = 100% 对冲工具