Forward Contracts
Lecture 4: Futures and Forwards: A forward contract is an agreement between two parties in which one party, the buyer (long), agrees to buy from the other party, the seller (short), something (i.e., underlying Markets, Basic Applications, and Pricing asset) at a later date (i.e., maturity date) at a price agreed Principles upon (i.e., delivery or forward prices) today
Exclusively over-the-counter
The contract is an over-the-counter (OTC) agreement between 2 companies
01135531: Risk Management and Dr. Nattawut Jenwittayaroje, CFA No physical facilities for trading Financial Instrument Faculty of Commerce and Accountancy OTC market consisting of direct communications among major Chulalongkorn University financial institutions
1 2
Futures Contracts Forward Contracts Versus Futures Similar in principle to forward contracts, but a futures contract is traded on an exchange, while a forward contract is traded OTC. Forward contracts Futures the contracts are standardized and specified by the exchange, making trading in a secondary market possible. Trade on OTC markets Traded on exchanges
Give up flexibility available in forward contacting for the sake of Not standardized Standardized contract liquidity. Specific delivery date Range of delivery dates Forward contracts: the terms of the contract (contract size, maturity Settled at end of contract Settled daily (by daily date, and etc.) can be tailored to the needs of the traders. marking to market) Delivery or final cash Virtually no credit risk – Futures exchanges provide a mechanism settlement usually takes Usually closed out prior to (known as the clearinghouse) that guarantee that the contract will be place maturity honored. For forwards contracts, creditworthiness of the seller is important.
3 4 Derivatives Markets in Thailand
Thailand Futures Exchange pcl. (TFEX) SET50 Index SET 50 Index Futures Futures Contract Single Stock Futures Specifications • For example, ADVANC, PTT, and PTTEP
Gold Futures, Silver Futures, and Brent Crude Oil Futures
USD Futures
Interest Rate Futures
SET 50 Index options • Call options • Put options
Agricultural Futures Exchange of Thailand (AFET) www.tfex.co.th Futures contracts on Natural Rubber Ribbed Smoked Sheets No 3 at 21 Mar 13 Futures contracts on White Rice 5% Both Options
Futures contracts on Tapioca Chip 5 6
The Specification of Futures Contracts Underlying asset Single Stock Futures Contract Particularly for commodity futures, the exchange sets allowable grade of a commodity Specifications Delivery location Place and means of delivery Contract size, e.g. For a crude oil futures contract, 1,000 barrels For the Dow Jones stock index futures, $10 per index point For the SET50 index futures, Baht1,000 per index point For a Eurodollar futures contract, $1 million of a Eurodollar time deposit www.tfex.co.th at 21 Mar 13 Quotation Specify how a price of a futures is quoted. E.g. for the CBOT’s corn
7 futures, prices are quoted in cents per bushel 8 The Specification of Futures Contracts TFEX’s SET 50 Index Futures Delivery months (expiration months)
The main delivery months for futures are March, June, September and December. Deliverable or cash settlement contracts
Deliverable contract: settled by delivery of the item
Cash settlement: settled by the payment of cash SET 50 index spot = 880.7 www.tfex.co.th at 13 Jan 2014 Daily price movement limits Settlement price (SP): this usually is an average of the prices of the last few Prevent large price movement from speculators. trades of the day. The settlement price is used to mark-to-market the position. Position limits The max. no. of contracts that an investor may hold. Volume: A number of contracts traded Open interest (OI): The number of futures contracts outstanding at any given Prevent speculators from having big influence on the market in time. 9 10
TFEX’s Gold & Single Stock Futures TFEX’s USD and Brent crude Futures
USD spot = 33.02 www.bot.or.th
Gold spot = 19,450
KTB spot = 16.50 11 Brent spot = 106.77*33.02 = 3,525 12 AFET’s Futures Example of Futures Listing on CBOT
13 14
Gold Futures
สินคาอางอิง ทองคําแทงที่มีความบริสุทธิ์ 96.5% ขนาดของสัญญา 1 สัญญามีขนาดเทากับ ทองคําน้ําหนัก 50 บาท เดือนที่สัญญาสิ้นสุดอายุ เดือนคู (ก.พ., เม.ย., มิ.ย., ส.ค., ต.ค., ธ.ค.) ใกลที่สุด 3 ลําดับ ชวงราคาซื้อขายขนตั้ ่ํา 10 บาท ตอ 1 สัญญา ชวงการเปลี่ยนแปลงของ ไมเกิน + 20 % ของราคาที่ใชชําระราคาในวันทําการกอนหนา ราคาสูงสุดแตละวัน เวลาซื้อขาย Pre-open : 9:15 - 9:45 Morning : 9:45 - 12:30 Pre-open : 14:00 - 14:30 Afternoon: 14:30 - 16:55 ราคาทใชี่ ้ชําระในวนสั ุดท้าย วันทําการกอนวันทําการสุดทายของเดอนทื ี่สัญญาสิ้นสุดอายุ โดย ในวันนั้น สัญญาที่จะหมดอายุจะซื้อขายไดถ ึงเวลา 16.30 น. 15 16 กราฟแสดงราคาทองคาํ spot กบั ราคาทองคาฟํ ิวเจอร์ส ราคา Gold Spot 13 มค. 2557
ราคา Gold Futures 13 มค. 2557
17 18
การทากํ าไรในตลาดขาขํ ้ึน GFM10 เปรียบเทียบทองคาํ (spot) กบั โกลดฟ์ ิวเจอร์ส (futures) ซื้อ มูลคา 19,900 ทองคาํ โกลดฟวเจอร ส 196,000
เงินลงทนชุ ําระเงินเต็มมลคู าวางเงินค้ําประกันประมาณ 10%
การสงมอบสินคาสงมอบจรงชิ ําระเปนเงินสด ขาย มูลคา 19,600 199,000 กลยุทธการทํากําไร ทํากําไรไดเฉพาะขาขึ้นทํากําไรไดทั้งขาขึ้นและขาลง
ราคาซื้อขาย ประกาศโดยสมาคมผูคาทอง เปลี่ยนแปลงตลอดวนตามการซั ื้อขาย ในตลาด
ระยะเวลาการลงทุน ระยะกลาง-ยาว ระยะสั้นวันตอว นั กาไรํ = 199,000 – 196,000 = 3,000 เงินลงทุน 15,000 กาไรรํ ้อยละ 20% เงนประกิ นั
19 20 การทากํ าไรในตลาดขาลงํ Clearinghouse GFM10 19,600 The futures exchange provides a clearing mechanism. Without a clearinghouse, traders will face a counter-party ซื้อ มูลคา risk 192,500 With clearing house, each trader only has an obligation with ขาย มูลคา the clearinghouse 196,000 The clearinghouse becomes 19,250 The seller of the contract for the long position
The buyer of the contract for the short position
กาไรํ = 196,000 – 192,500 = 3,500 The clearinghouse’s position nets to zero เงินลงทุน 15,000 กาไรรํ ้อยละ 23%
21 22
Clearinghouse Clearinghouse
23 24 Margin Account Daily Settlements (Marking to Market) Furthermore, the profit/loss on a futures contract is settled daily. Since each trader has an obligation with the exchange, and futures contracts expose to risk of loss. Winning party
To protect the exchange from a possible loss on a futures contract, the The surplus (above initial margin) from its account can be exchange requires each trader to deposit an initial margin. withdrawn.
The initial margin (deposit) is usually required between 5% to 15% of Otherwise, interest is paid on the funds left in this account. the total value of the contract. For example, for SET50 index futures, the Losing party initial margin is 85,000 per contract, or about 85,000/(1,000*880) = 10.4%. Additional payments if the value of the position falls below During the life of a contract, the trader must maintain their account maintenance margin above maintenance margin level, e.g., 5% of the total value of the contract. For SET50 index futures, the maintenance margin is 60,000 per Marking to market can be more than one time per day (i.e., contract, or about 60,000/(1,000*880) = 6.8%. Intra-day margin call)
When falls below the maintenance level, they will receive a margin For a forward contract, the profit/loss is realized and settled only call and is requested to top up the margin account to the initial margin once at the maturity. level. 25 26
Day Future Daily gain/loss Margin account balance Margin Example Price for LONG positions call
Suppose that the SFE SPI 200 index futures contract is now 0 3,500 $8,750 traded at 3,500 index points. Its contract size is $25 per index 1 3,600 100×25= $2,500 $11,250 2 3,700 100×25= $2,500 $13,750 point. The initial and maintenance margins for each contract 3 3,650 -50×25= -$1,250 $12,500 are 10% and 5% of the value of the contract respectively. Day Future Daily gain/loss Margin account balance Margin Initial margin = 10% $87,500 (3,500$25 ) = $8,750 Price for SHORT positions call 0 3,500 $8,750 Maintenance margin =5% $87,500 (3,500$25 ) = $4,375 1 3,600 -100×25= -$2,500 $6,250 - 2 3,700 -100×25= -$2,500 $3,750 $5,000 3 3,650 50×25= $1,250 $1,250+$8,750=$10,000 -
27 28 Closing Out Positions (Reversing Trading) Closing Out Positions and Open Interest A trader can close out a position at anytime before the settlement date. The number of contracts outstanding (i.e. number of either long or short contracts outstanding) Closing out a long position Almost all traders (i.e., about 99%), however, liquidate (i.e., taking an a short position on the same contract. closeout) their positions before the contract maturity date. A trader bought a June interest rate future contract at 3,200.
If in April, the interest rates futures are traded at 3,300.this Futures contracts rarely result in actual delivery of the trader can close out the position and realise the profit by underlying asset. selling (shorting) the contract. The fraction of contracts that result in actual delivery is estimated to range from less than 1 to 3%, depending on the commodity and the activity in the contract. Closing out a short position
taking a long position on the same contract.
29 30
Day Future Daily gain/loss Margin account balance Margin Price for LONG positions call Forward Contracts Versus Futures 0 3,500 $8,750 1 3,600 100×25 = $2,500 $11,250 The old Forward contracts Futures 2 3,700 100×25 = $2,500 $13,750 LONG -50×25= - $1,250 trader sells 3 3,650 $12,500 - $12,500 the futures Trade on OTC markets Traded on exchanges contract to 3 3,650 $9,125 Not standardized Standardized contract a new 4 3,600 -50×25 = -$1,250 $7,875 LONG Specific delivery date Range of delivery dates trader. Day Future Daily gain/loss Margin account balance Margin Settled at end of contract Settled daily Price for SHORT positions call Delivery or final cash Usually closed out prior to 0 3,500 $8,750 settlement usually takes maturity 1 3,600 -100×25= -$2,500 $6,250 - place 2 3,700 -100×25= -$2,500 $3,750 $5,000 3 3,650 50×25= $1,250 $1,250+$8,750=$10,000 - The clearinghouse and margin account show how 4 3,600 50×25= $1,250 $11,250 31 daily settlement and closing-out positions work 32 Open Interest and Volume Open Interest and Volume Consider the following example on how to compute open interest and volume. Consider the following example on how to compute open interest and Time Trading Activity Open Volume Who are in the volume. Interest market? Jan 1 A buys 1 futures contract and B 1 1 A(+1) : B(-1) Time Trading Activity Open Volume Who are in sells 1 futures contract Interest the market? Jan 2 E buys 1 futures contract and A sells 1 futures contract Jan 1 A buys 1 futures contract and 1 1 A(+1) : B(-1) B sells 1 futures contract Jan 3 B buys 1 futures contract and E sells 1 futures contract Jan 2 C buys 10 futures contracts and D sells 5 futures Time Trading Activity Open Volume Who are in the contracts and E sells 5 Interest market? futures contracts Jan 1 A buys 1 futures contract and B 1 1 A(+1) : B(-1) Jan 3 B buys 3 futures contracts sells 1 futures contract and A sells 1 futures contract Jan 2 C buys 2 futures contracts and D and C sells 2 futures sells 2 futures contracts contracts Jan 3 B buys 1 futures contract and D sells 1 futures contract 33 34
Speculating using Futures and Leverage Hedging using futures A crude oil futures contract calls for delivery of 1,000 barrels of oil. The current future price for delivery in May is $67.15 per Short hedges barrel. Suppose the initial margin requirement for the oil contract It is a hedge that involves a short position in futures is 10%. contracts Expect crude oil prices are going to increase It is used when the hedger already own an asset and Long oil futures expects to sell it at some time in the future. Initial margin = 10%$67,150 ($67.15 1,000 ) = $6,715 If the price of the oil futures increase by $2 ($2/$67.15 = 2.98%) Long hedges create the gain to the long futures =$21,000 = $2,000 or 2,000/6,715 = 29.8% It is a hedge that involves a long position in futures contracts The 10-to-1 ratio of % change reflects the leverage inherent in the future position. It is used when the hedger knows it will purchase a certain asset in the futures. Leverage: Ability to take on relatively large exposure to the market
using futures and options for a relatively small initial outlay. 35 36 Example: Hedging using Futures Example: Hedging using Futures Consider an oil distributor (i.e. hedger) plans to sell 100,000 bbls of oil in May that wishes to hedge against a possible decline in oil prices. Each oil futures contract calls for
delivery of 1,000 bbls of oil. F0 = $67.15 per barrel. Hedging strategy: short 100 oil futures contracts
Consider 3 possible spot prices (ST) of oil in May.
ST
ST
F0 -ST
- When the spot price (ST) in May is low, the low revenue from spot contract is offset by the profit from the short futures positions - When pt is high, the high revenue is offset by the loss from the short futures. 37 38 - All cases, end up 6,715,000: elimination risk: uncertain of the spot price.
Forwards/Futures – pricing principle 1. Gold: An Arbitrage Opportunity? Suppose that:
The spot price of gold is US$900 Should there be any relationship between spot The 1-year futures price of gold is US$960 and forward/future prices? The 1-year US$ interest rate is 5% per annum Is there an arbitrage opportunity? Is forward/futures price a consensus expected Action at time 0 Initial Cash Cash Flow at spot price at maturity? Flow Maturity Borrow $900 +900 -900(1+0.05)1
Buy gold for $900 -900 ST
Short gold futures at F0=960 0 960 - ST TOTAL 0 960-900(1+0.05)1 = $15 39 40 2. Gold: Another Arbitrage Opportunity? The Forward/Futures Price of Gold
Suppose that: If the spot price of gold is S and the futures price for a contract deliverable in T years is F, then The spot price of gold is US$900 F = S (1+r )T Cost-of-carry relationship The 1-year futures price of gold is US$890 where r is the 1-year (domestic currency) risk-free interest rate. The 1-year US$ interest rate is 5% per annum The continuous version of cost of carry model F = SerT Is there an arbitrage opportunity? where r is the 1-year continuously compounded risk-free interest rate.
Action at time 0 Initial Cash Cash Flow at Future price (relative cost of buying a gold with deferred delivery) = spot Flow Maturity price (cost of buying the gold in the market) and carrying it in inventory. Cost of carrying gold = risk-free rate Sell short gold for $900 +900 -ST If this parity is violated, this can be arbitraged as previously shown. Lend $900 -900 +900(1+1.05)1 Arbitrage: strategy to exploit the mispricing that will produce ariskless profit. Long gold futures at F0=890 0 ST - 890 In our examples, S=900, T=1, and r=0.05 so that 1 TOTAL 0 900(1+1.05) -890 = $55 F = 900(1+0.05)1 = 945 $900 is spot cost, and $45 is the 41 cost-of-carry 42
3. Oil: An Arbitrage Opportunity? 4. Oil: Another Arbitrage Opportunity? Suppose that: Suppose that: - The spot price of oil is US$120 - The spot price of oil is US$120 - The quoted 1-year futures price of oil is US$135 - The quoted 1-year futures price of oil is US$119 - The 1-year US$ interest rate is 5% per annum - The 1-year US$ interest rate is 5% per annum - The storage cost of oil is $2 per barrel - The storage cost of oil is $2 per barrel Is there an arbitrage opportunity? Is there an arbitrage opportunity? Action at time 0 Initial Cash Cash Flow at Maturity Action at time 0 Initial Cash Cash Flow at Maturity Flow Flow Borrow $120 +120 -120(1+0.05)1 Sell short oil for $120 +120 -ST 1 Buy oil for $120 -120 ST Lend $120 -120 +120(1+0.05) Cost of storing oil 0 -2 Save cost of storing oil 0 +2 Short oil futures at F =135 0 135 - S 0 T Buy oil futures at F0=119 0 ST - 119 TOTAL 0 135 - 120(1+0.05)1 - 2 = $7 TOTAL 0 120(1+0.05)1+2 - 119= $9 43 44 The Forward/Futures Price of Asset with Storage Cost 5. Stock Index: An Arbitrage Opportunity? Suppose that: If the spot price of asset is S and the futures price for a contract - The spot price of SET50 index is 450 deliverable in T years is F, then - The quoted 6-month futures price of SET50 is 465 F = S (1+r)T + s Cost-of-carry relationship - The 1-year Thai Baht interest rate is 5% per annum where r is the 1-year (domestic currency) risk-free rate of interest, - The dividends paid from constituent stocks in the SET50 are Baht 5 in the next 6 months and s is the dollar storage cost Is there an arbitrage opportunity? The continuous version of cost of carry model F = Se(r+s)T Action at time 0 Initial Cash Flow at Maturity where r and s is the 1-year continuously compounded risk-free Cash Flow interest rate and storage cost rate. 1/2 Cost of carrying asset = risk-free rate and storage cost Borrow $450 +450 -450(1+0.05)
If this parity is violated, this can be arbitraged as previously shown. Buy SET50 for $450 -450 ST In our examples, S=120, T=1, r=0.05, and s=$2 so that Receive dividends 0 +5 1 F = 120(1+0.05) +2 = 128 Short SET50 futures at F0=465 0 465 - ST 1/2 $120 is spot cost, and $8 is TOTAL 0 465 - 450(1+0.05) + 5 = $8.9 the cost-of-carry 45 46
6. Stock Index: An Arbitrage Opportunity? The Forward/Futures Price of Asset with Dividend
Suppose that: If the spot price of asset is S and the futures price for a contract - The spot price of SET50 index is 450 deliverable in T years is F, then - The quoted 6-month futures price of SET50 is 452 T - The 1-year Thai Baht interest rate is 5% per annum F = S (1+r) -D Cost-of-carry relationship - The dividends paid from constituent stocks in the SET50 are Baht 5 per where r is the 1-year (domestic currency) risk-free rate of interest, annum and D is the dollar amount of dividend paid Is there an arbitrage opportunity? The continuous version of cost of carry model F = Se(r-d)T Action at time 0 Initial Cash Flow at Maturity where r and d is the 1-year continuously compounded risk-free Cash Flow interest rate and dividend yield.
Sell SET50 for $450 +450 -ST NetCostofcarryingasset = risk-free rate minus dividend paid Lend $450 -450 +450(1+0.05)1/2 If this parity is violated, this can be arbitraged as previously shown. Pay dividends 0 -5 In our examples, S=450, T=0.5, r=0.05, and D=$5 so that F = 450(1+0.05)1/2 - 5 = 456.1 Buy SET50 futures at F0=452 0 ST – 452 TOTAL 0 450(1+0.05) 1/2 - 5 – 452 = $4.1 $450 is spot cost, and $6.1 is 47 the net cost-of-carry 48 7. Currency: An Arbitrage Opportunity? 8. Currency: An Arbitrage Opportunity? Suppose that: Suppose that: - The spot price of USD is 33 baht - The spot price of USD is 33 baht - The quoted 1-month futures price of USD is 33.8 baht - The quoted 1-month futures price of USD is 32.8 baht - The 1-year Thai Baht interest rate is 5% per annum, and the 1-year US$ - The 1-year Thai Baht interest rate is 5% per annum, and the 1-year US$ interest rate is 4% per annum interest rate is 4% per annum Is there an arbitrage opportunity? Is there an arbitrage opportunity? Action at time 0 Initial Cash Flow at Maturity Action at time 0 Initial Cash Flow at Maturity US risk-free rate of 4% Cash Flow US risk-free rate of 4% Cash Flow
1/12 Borrow 33 baht +33 -33(1+0.05) Sell USD for 33 baht +33 -ST 1/12 Buy USD for 33 baht -33 ST Lend 33 baht -33 +33(1+0.05) Receive “dividends” 0 +33(1+0.04)1/12 - 33 Pay “dividends” 0 - [33(1+0.04)1/12 – 33]
Short USD futures at F0=33.8 0 33.8 - ST Long USD futures at F0=32.8 0 ST - 32.8 TOTAL 0 33.8 – [33(1+0.05) 1/12 TOTAL 0 [33(1+0.05) 1/12 -33(1+0.04)1/12 + 33] Terms in the bracket can be -33(1+0.04)1/12 + 33] = .77 Terms in the bracket can be – 32.8 = .23 approximated by 33(1+0.05-0.04)1/12 49 approximated by 33(1+0.05-0.04)1/12 50
The Forward/Futures Price of Foreign Futures Markets: Contango vs Backwardation Currency Assets In a Contango market, the futures price exceeds the spot price, that is,
If the spot price of asset is S and the futures price for a contract f0(T) > S0. See Table 9.2. deliverable in T years is F, then Cost-of-carry relationship When f0(T) < S0, convenience yield is c , an additional return from holding F = S (1 + r - ρ )T asset when in short supply/high demand or a non-pecuniary return (e.g., The continuous version of cost of carry model F = Se(r-ρ)T the utility from living in the house owned). where r is the 1-year domestic currency risk-free interest rate, When the commodity has a convenience yield, the futures price may be and ρ is the foreign currency risk-free interest rate less than the spot price plus the cost of carry. In that case, the market is said to be at less than full carry and in Backwardation or inverted (See NetCostofCarryingasset = domestic risk-free rate minus foreign Table 9.3). risk-free rate Market can be both backwardation and contango --> Table 9.4. If this parity is violated, this can be arbitraged as previously shown. In our examples, S=33, T=1/12, r=0.05, and d=0.04 so that The inability to sell short the asset and the reluctance on the part of holders of the commodity to sell it when its price is higher than it should be can F = 33(1+0.05-0.04)1/12 = 33.03 also produce backwardation in commodity markets.
33 is spot cost, and .03 is the net cost-of-carry 51 52 www.tfex.co.th as of 22 March 2013
53 54
www.set.or.th, www.tfex.co.th, www.goldtraders.or.th as of 29 March 2013
55