Definition of Futures

Futures

A term used to designate all contracts covering the sale of financial instruments or physical
commodities for future delivery on a commodity exchange.

Deferred futures

The most distant months of a futures contract. A bond that sells at a discount and does not
pay interest for an initial period, typically from three to seven years. Compare step-up bond and payment-inkind
bond.

Futures commission merchant

A firm or person engaged in soliciting or accepting and handling orders for
the purchase or sale of futures contracts, subject to the rules of a futures exchange and, who, in connection
with such solicitation or acceptance of orders, accepts any money or securities to margin any resulting trades
or contracts. The FCM must be licensed by the CFTC. Related: commission house , omnibus account

Futures contract

Agreement to buy or sell a set number of shares of a specific stock in a designated future
month at a price agreed upon by the buyer and seller. The contracts themselves are often traded on the futures
market. A futures contract differs from an option because an option is the right to buy or sell, whereas a
futures contract is the promise to actually make a transaction. A future is part of a class of securities called
derivatives, so named because such securities derive their value from the worth of an underlying investment.

Futures contract multiple

A constant, set by an exchange, which when multiplied by the futures price gives
the dollar value of a stock index futures contract.

Futures market

A market in which contracts for future delivery of a commodity or a security are bought or sold.

Futures option

An option on a futures contract. Related: options on physicals.

Futures price

The price at which the parties to a futures contract agree to transact on the settlement date.

London International Financial Futures Exchange (LIFFE)

A London exchange where Eurodollar futures
as well as futures-style options are traded.

London International Financial Futures Exchange (LIFFE)

London exchange where Eurodollar futures as well as futures-style options are traded.

Most distant futures contract

When several futures contracts are considered, the contract settling last.
Related: nearby futures contract

National Futures Association (NFA)

The futures industry self regulatory organization established in 1982.

Nearby futures contract

When several futures contracts are considered, the contract with the closest
settlement date is called the nearby futures contract. The next futures contract is the one that settles just after
the nearby futures contract. The contract farthest away in time from settlement is called the most distant
futures contract.

Next futures contract

The contract settling immediately after the nearby futures contract.

Spot futures parity theorem

Describes the theoretically correct relationship between spot and futures prices.
Violation of the parity relationship gives rise to arbitrage opportunities.

Theoretical futures price

Also called the fair price, the equilibrium futures price.

futures contract

Exchange-traded promise to buy or sell an asset in the future at a prespecified price.

Futures Contract

A contract in which the seller agrees to provide something to a buyer at a specified future date at an agreed price.

Actuals

The physical commodity underlying a futures contract. Cash commodity, physical.

Advance commitment

A promise to sell an asset before the seller has lined up purchase of the asset. This
seller can offset risk by purchasing a futures contract to fix the sales price.

Backwardation

A market condition in which futures prices are lower in the distant delivery months than in
the nearest delivery month. This situation may occur in when the costs of storing the product until eventual
delivery are effectively subtracted from the price today. The opposite of contango.

Basis

Regarding a futures contract, the difference between the cash price and the futures price observed in the
market. Also, it is the price an investor pays for a security plus any out-of-pocket expenses. It is used to
determine capital gains or losses for tax purposes when the stock is sold.

Call

An option that gives the right to buy the underlying futures contract.

Cash commodity

The actual physical commodity, as distinguished from a futures contract.

Cash delivery

The provision of some futures contracts that requires not delivery of underlying assets but
settlement according to the cash value of the asset.

Cash settlement contracts

futures contracts, such as stock index futures, that settle for cash, not involving
the delivery of the underlying.

CFTC

The Commodity futures Trading Commission is the federal agency created by Congress to regulate
futures trading. The Commodity Exchange Act of 1974 became effective April 21, 1975. Previously, futures
trading had been regulated by the Commodity Exchange Authority of the USDA.

Cheapest to deliver issue

The acceptable Treasury security with the highest implied repo rate; the rate that a
seller of a futures contract can earn by buying an issue and then delivering it at the settlement date.

Chicago Mercantile Exchange (CME)

A not-for-profit corporation owned by its members. Its primary
functions are to provide a location for trading futures and options, collect and disseminate market information,
maintain a clearing mechanism and enforce trading rules.

Clearing house / Clearinghouse

An adjunct to a futures exchange through which transactions executed its floor are settled by a
process of matching purchases and sales. A clearing organization is also charged with the proper conduct of
delivery procedures and the adequate financing of the entire operation.

Commission house

A firm which buys and sells future contracts for customer accounts. Related: futures
commission merchant, omnibus account.

Commitment

A trader is said to have a commitment when he assumes the obligation to accept or make
delivery on a futures contract. Related: Open interest

Commodities Exchange Center (CEC)

The location of five New York futures exchanges: Commodity
Exchange, Inc. (COMEX), the New York Mercantile exchange (NYMEX), the New York Cotton Exchange,
the Coffee, Sugar and Cocoa exchange (CSC), and the New York futures exchange (NYFE). common size
statement A statement in which all items are expressed as a percentage of a base figure, useful for purposes of
analyzing trends and the changing relationship between financial statement items. For example, all items in
each year's income statement could be presented as a percentage of net sales.

Commodity

A commodity is food, metal, or another physical substance that investors buy or sell, usually via
futures contracts.

Contango

A market condition in which futures prices are higher in the distant delivery months.

Contract month

The month in which futures contracts may be satisfied by making or accepting a delivery.
Also called value managers, those who assemble portfolios with relatively lower betas, lower price-book and
P/E ratios and higher dividend yields, seeing value where others do not.

Convergence

The movement of the price of a futures contract toward the price of the underlying cash
commodity. At the start, the contract price is higher because of the time value. But as the contract nears
expiration, the futures price and the cash price converge.

Conversion factors

Rules set by the Chicago Board of Trade for determining the invoice price of each
acceptable deliverable Treasury issue against the Treasury Bond futures contract.

Cross hedging

The practice of hedging with a futures contract that is different from the underlying being
hedged.

Delivery

The tender and receipt of an actual commodity or financial instrument in settlement of a futures contract.

Delivery notice

The written notice given by the seller of his intention to make delivery against an open, short
futures position on a particular date. Related: notice day

Delivery options

The options available to the seller of an interest rate futures contract, including the quality
option, the timing option, and the wild card option. Delivery options make the buyer uncertain of which
Treasury Bond will be delivered or when it will be delivered.

Delivery points

Those points designated by futures exchanges at which the financial instrument or
commodity covered by a futures contract may be delivered in fulfillment of such contract.

Delivery price

The price fixed by the Clearing house at which deliveries on futures are in invoiced; also the
price at which the futures contract is settled when deliveries are made.

Derivative instruments

Contracts such as options and futures whose price is derived from the price of the
underlying financial asset.

Equity

Represents ownership interest in a firm. Also the residual dollar value of a futures trading account,
assuming its liquidation at the going market price.

Exchange

The marketplace in which shares, options and futures on stocks, bonds, commodities and indices
are traded. Principal US stock exchanges are: New York Stock Exchange (NYSE), American Stock Exchange
(AMEX) and the National Association of Securities Dealers (NASDAQ)

Fair price

The equilibrium price for futures contracts. Also called the theoretical futures price, which equals
the spot price continuously compounded at the cost of carry rate for some time interval.

First notice day

The first day, varying by contracts and exchanges, on which notices of intent to deliver
actual financial instruments or physical commodities against futures are authorized.

Hedging

A strategy designed to reduce investment risk using call options, put options, short selling, or futures
contracts. A hedge can help lock in existing profits. Its purpose is to reduce the volatility of a portfolio, by
reducing the risk of loss.

Implied repo rate

The rate that a seller of a futures contract can earn by buying an issue and then delivering
it at the settlement date. Related: cheapest to deliver issue

Index arbitrage

An investment/trading strategy that exploits divergences between actual and theoretical
futures prices.

Initial margin requirement

When buying securities on margin, the proportion of the total market value of
the securities that the investor must pay for in cash. The Security Exchange Act of 1934 gives the board of
governors of the Federal Reserve the responsibility to set initial margin requirements, but individual
brokerage firms are free to set higher requirements. In futures contracts, initial margin requirements are set by
the exchange.

International Monetary Market (IMM)

A division of the CME established in 1972 for trading financial
futures. Related: Chicago Mercantile Exchange (CME).

In-the-money

A put option that has a strike price higher than the underlying futures price, or a call option
with a strike price lower than the underlying futures price. For example, if the March COMEX silver futures
contract is trading at $6 an ounce, a March call with a strike price of $5.50 would be considered in-the-money
by $0.50 an ounce.
Related: put.

Inverted market

A futures market in which the nearer months are selling at price premiums to the more
distant months. Related: premium.

Invoice price

The price that the buyer of a futures contract must pay the seller when a Treasury Bond is delivered.

Last trading day

The final day under an exchange's rules during which trading may take place in a particular
futures or options contract. Contracts outstanding at the end of the last trading day must be settled by delivery
of underlying physical commodities or financial instruments, or by agreement for monetary settlement
depending upon futures contract specifications.

Long hedge

The purchase of a futures contract(s) in anticipation of actual purchases in the cash market. Used
by processors or exporters as protection against an advance in the cash price. Related: Hedge, short hedge

Maintenance margin requirement

A sum, usually smaller than -but part of the original margin, which must
be maintained on deposit at all times. If a customer's equity in any futures position drops to, or under, the
maintenance margin level, the broker must issue a margin call for the amount at money required to restore the
customer's equity in the account to the original margin level. Related: margin, margin call.

Marked-to-market

An arrangement whereby the profits or losses on a futures contract are settled each day.

Nearby

The nearest active trading month of a financial or commodity futures market. Related: deferred futures

Nominal price

Price quotations on futures for a period in which no actual trading took place.

Normal backwardation theory

Holds that the futures price will be bid down to a level below the expected
spot price.

Omnibus account

An account carried by one futures commission merchant with another futures commission
merchant in which the transactions of two or more persons are combined and carried in the name of the
originating broker, rather than designated separately. Related: commission house.

Open-outcry

The method of trading used at futures exchanges, typically involving calling out the specific
details of a buy or sell order, so that the information is available to all traders.

Options on physicals

Interest rate options written on fixed-income securities, as opposed to those written on
interest rate futures contracts.

Overlay strategy

A strategy of using futures for asset allocation by pension sponsors to avoid disrupting the
activities of money managers.

Pit

A specific area of the trading floor that is designed for the trading of commodities, individual futures, or
option contracts.
Pit committee
A committee of the exchange that determines the daily settlement price of futures contracts.

Premium

1) Amount paid for a bond above the par value.
2) The price of an option contract; also, in futures
trading, the amount the futures price exceeds the price of the spot commodity. Related: inverted market premium payback period. Also called break-even time, the time it takes to recover the premium per share of a
convertible security.

Put

An option granting the right to sell the underlying futures contract. Opposite of a call.

Quality option

Also called the swap option, the seller's choice of deliverables in Treasury Bond and Treasury
note futures contract. Related: cheapest to deliver issue

Registered representative

A person registered with the CFTC who is employed by, and soliciting business
for, a commission house or futures commission merchant.

Reversing trade

Entering the opposite side of a currently held futures position to close out the position.

Security deposit (initial)

Synonymous with the term margin. A cash amount of funds that must be deposited
with the broker for each contract as a guarantee of fulfillment of the futures contract. It is not considered as
part payment or purchase. Related: margin

Settlement price

A figure determined by the closing range which is used to calculate gains and losses in
futures market accounts. Settlement prices are used to determine gains, losses, margin calls, and invoice
prices for deliveries. Related: closing range.

Short hedge

The sale of a futures contract(s) to eliminate or lessen the possible decline in value ownership of
an approximately equal amount of the actual financial instrument or physical commodity.
Related: Long hedge.

SIMEX (Singapore International Monetary Exchange)

A leading futures and options exchange in Singapore.

Spot month

The nearest delivery month on a futures contract.

Spread

1) The gap between bid and ask prices of a stock or other security.
2) The simultaneous purchase and sale of separate futures or options contracts for the same commodity for delivery in different months.
Also known as a straddle.
3) Difference between the price at which an underwriter buys an issue from a firm
and the price at which the underwriter sells it to the public.
4) The price an issuer pays above a benchmark fixed-income yield to borrow money.

Stock replacement strategy

A strategy for enhancing a portfolio's return, employed when the futures
contract is expensive based on its theoretical price, involving a swap between the futures, treasury bills
portfolio and a stock portfolio.

Substitute sale

A method for hedging price risk that utilizes debt-market instruments, such as interest rate
futures, or that involves selling borrowed securities as the primary assets.

Switching

Liquidating an existing position and simultaneously reinstating a position in another futures
contract of the same type. Symmetric cash matching An extension of cash flow matching that allows for the
short-term borrowing of funds to satisfy a liability prior to the liability due date, resulting in a reduction in the
cost of funding liabilities.

Taking delivery

Refers to the buyer's actually assuming possession from the seller of the asset agreed upon
in a forward contract or a futures contract.

Tender

To offer for delivery against futures.

Timing option

For a Treasury Bond or note futures contract, the seller's choice of when in the delivery month to deliver.

Trading halt

Trading of a stock, bond, option or futures contract can be halted by an exchange while news is
being broadcast about the security.

Triple witching hour

The four times a year that the S&P futures contract expires at the same time as the S&P
100 index option contract and option contracts on individual stocks.

Unmatched book

If the average maturity of a bank's liabilities is less than that of its assets, it is said to be
running an unmatched book. The term is commonly used with the Euromarket. Term also refers to the
condition when a firm enters into OTC derivatives contracts and chooses to hedge that risk by not making
trades in the opposite direction to another financial intermediary. In this case, the firm with an unmatched
book hedges its net market risk with futures and options, usually.
Related expressions: open book and short book.

Wild card option

The right of the seller of a Treasury Bond futures contract to give notice of intent to deliver
at or before 8:00 p.m. Chicago time after the closing of the exchange (3:15 p.m. Chicago time) when the
futures settlement price has been fixed. Related: Timing option.

Straddle

A strategy used in trading options or futures. It involves
simultaneously purchasing put and call options with the same exercise price
and expiration date, and it is most profitable when the price of the underlying
security is very volatile.

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