(JPMNT) Journal of Process Management – New Technologies, International Vol. 4, No.3, 2016.

FORWARD, FUTURE AND OPTIONS ON EXCHANGE

PhD Ljiljana Stoši ć Mihajlovi ć, Professor High School of Applied Studies, Vranje, Serbia, [email protected] MSc Ivana Zdravkovi ć „Radoje Domanovi ć“ School, Vranje, Serbia, [email protected]

Professional Paper doi:10.5937/jouproman4-11338

Abstract: The main motive of the formation • Forwards Contracts, and use of forward contracts and futures, and • A liquid futures contracts - futures options, was certainly profit. Making financial • markets more efficient, in terms of expanding the range of available financial instruments and reduction in transaction costs, these financial 1. FORWARD CONTRACTS innovations are beneficial for both and managers company. Primary purpose of derivatives Forward is the simplest type of such as forwards, futures and options is to enable financial derivatives. A classic futures control risks by investitures and primarily from contract. This is a contract under which the inadequate price trends for all types of assets that buyer and seller agree and express their could be subject to transactions in financial markets. will, the delivery of a certain quantity and Keywords: forward contracts, futures contracts, quality of the assets on a specific date in the options, , future. The price at which it will be executed INTRODUCTION purchase and sale contracts in advance. The existence of forward contracts is associated securities or financial with distinguishing two types of markets: derivatives are a large group of financial instruments. They are called so because • prompt, cash markets, where delivery and their value is derived from the value of payment is made immediately, not later other underlying assets located in their than 5 days basis. They do not reflect the property • futures, where the billing, payment and (shares) not indebted (bonds), but carry delivery carried out on a certain day in the with them a kind of conditional - contingent future. rights to other forms of financial assets. The Forward contract or the futures value and price of derivatives depends not contract is an agreement between the two only on the supply and demand for them, entities, the buyer and the seller, on the sale but also on the value of a number of factors of certain assets - goods, which achieves to to which they relate. Financial derivatives take delivery of these assets - goods and its are very important to the business and risk final payment to be made in the future. management in financial markets. Allow the risk to be awarded much more rational It is believed that the first stock control. They are used by the hedger and exchange and commodity speculators, but about them later. In theory (forward) was created on 12 March 1851. In and practice, a distinction is made the CBOT in Chicago. Related to the following securities: delivery of 3,000 bushels of corn in June.

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Characteristics of forward contracts: 2. FUTURES CONTRACTS • Classic futures contract • Not standardized Futures are similar to forwards • Adjusted to the specific needs of essentially. Some even considered by the contracting parties authors since the variation of forward and • The transaction is performed on the futures originated from forward. But the OTC market fact is that the futures actually resulting • Do not forward the house. from forward contracts to represent a newer version or a modern type of futures Disadvantages of a forward contract are: contract. Similar, if not identical to that of forward contracts and futures are in fact • Inability to easily find other contracts concluded between the two sides, contractual party will accept the according to which one party - the seller terms of the contract undertakes to deliver precisely defined assets (money or goods or services) in • Insolvency Contracting Parties exactly the specified time limit and pre- • Susceptibility to risk of default - agreed price, while the buyer is obliged to default risk take over the assets and make the payment • Inability to trade on the secondary at a specified day (usually it is the day of market. delivery).

"Futures is a contract for the delivery Forward position can be twofold, of goods, or namely: at a pre-agreed futures price and the 1 contractual term in the future." 1) - when there is a defined obligation to buy assets that is specified in the Futures is also the expression of the contract, and will of the two sides of the assets, price and 2) Up - when there is an obligation to carry future delivery and payment. Futures buyer out a sale of assets which in turn is and seller sign a purchase contract, at a regulated, that is pre-defined as a forward predetermined price, or payment is not done contract. until the moment when the goods are not As an illustration, we give an example delivered to the purchaser in the future. The of pure interest forward. In her first need to contract also defines the conditions of defined debit instrument, or assets that will delivery and only when these conditions are be delivered under the contract (in a way, met, the payment is happening. "Futures are on time and according to the defined derivatives or derivative financial financial and quantitative elements). For instruments as they are derived from example, when a decides to sell products that are in their basis." 2 forward it eliminates the risk of changes interest rates for each subsequent sale of "According to the Law on Securities financial instruments in their portfolio, and of Serbia futures contract is defined as a this means that the bank determines the portable contract to sell standardized precise price at which to sell securities. On amounts of market material that could the other hand, the other party, or the conclude legal persons through brokers and customer forwards is also protected from with the help ." 3 changes in prices of securities in a transaction with the aforementioned financial institution. 1 Unkovi ć, M., Milosavljevi ć, M., Savremeno berzansko I elektronsko poslovanje, Singidunum, Beograd, pp.85 2 Ibidem, pp.86 3 Ibidem, pp. 87 51 www.japmnt.com (JPMNT) Journal of Process Management – New Technologies, International Vol. 4, No.3, 2016.

What is the difference between futures 1 Scalpel - they react to changes in the and forwards? Futures are highly minimum price of the day. standardized financial instruments and are 2. Day traders - like a scalpel but with a also called liquid futures contracts just different philosophy. because they are liquid and there is a 3. Positional traders - with the aim of different mechanism of payment of holding positions for more than a day. forwards. Further, among them the delivery is not linked to a specific date, like Especially important emphasized that forwards, but for the month in which it approaching maturity so gradually equalize must be done. respectively, settled futures prices and the Also, there are some certain freedom prices of assets from futures contracts. This on delivery, but the seller is obliged to still means that at maturity futures price inform the clearing house via the customer exactly coincide with the price of the assets when it will make the delivery. of the original contract on futures. Then, with the forwards no payment prior to maturity, the maturity date is carried out There are several types of futures, and delivery and payment, while the futures futures all can be divided into: market there is little difference - the buyer and seller take particular for • Edge - includes a number of different deposit, which ranges from 5 to 15% of the commodities: metals, agricultural products, contract value. Deposit guarantees delivery gas, oil, etc. and and payment. • Financial - some authors distinguish Futures can be traded on the Stock currency, foreign exchange, interest rate Exchange and all participants can be futures on securities, futures on market divided into two groups: indexes, etc.

Commodity futures contracts are liquid • hedger in which the underlying assets - the goods. • speculators "9 The goods which are usually traded

agricultural products - cereals (wheat, corn, Hedger the entities carrying out futures soybeans, rice); livestock; agro-industrial transactions with futures want to protect products (coffee, cocoa, cotton, sugar); themselves from risks and loss due to metals; oil; and natural gas. How could it be changes in prices, but also to bring more traded commodity futures trading is certainty and security in their business. As a necessary to standardize quantities. hedger occur , construction companies, etc. For example, a German "Financial futures involves a number of company engaged in exporting and she will different futures contracts, where as fixed 4 be made to pay exactly 45 days in euro. assets appear other materials market." Futures is essentially a real contract that Speculators are participants in the futures bears the rights and obligations of both the where the main motive is not to protect buyer and the seller. The buyer of the themselves from the risk of changes in asset futures contract has the right on assets prices, but to realize trading profit. They which was contracted futures and the accept the risk of buying or selling futures obligation to pay these assets. On the other contracts in order to earn. So, they are not hand, the seller of the futures contract is interested in commodities, but the entitled to receive the funds, and the difference in price you can achieve. There obligation to deliver assets. are the following types of speculators:

4 Ibidem, pp.88 52 www.japmnt.com (JPMNT) Journal of Process Management – New Technologies, International Vol. 4, No.3, 2016.

Around the fulfillment of obligations Arbitrageurs, while trade in the futures created by the clearing house, which always and securities that are the subject of futures has a zero position, I can not affect the price in order to generate profit from the price changes of individual futures contracts, difference. because the sum of the profit or loss equal to each other. 2.1 TYPES OF FUTURES CONTRACT Futures have the following characteristics: There are several types of futures contracts:

• • Standard - in terms of size, the trade Commodity futures-futures cycle in the month in which the trade represent standardized contract takes place, the day of delivery, between the seller and buyer, where quotes, minimal price changes, etc. the buyer to accept delivery of certain goods at the agreed price in a specified period in the future. • The ability to trade securities and

neutralize the original contract or the • same trade in the opposite direction. currency futures-trading of currency Only a few futures before the end of futures appear regularly participate, validity (maturity) such as traders and speculators hedger. The specificity of currency futures trading is that there are • The public market in which prices are arbitrageurs, who are trying to make available contracts - trading is done profit on the basis of spatial and shouting at the trading floor and the temporal variations in the amount of prices published on boards Stock the course. Exchange, the financial press or

through agencies. • Interest futures-futures are futures

contracts binding the seller to Participants in futures trade are: deliver and the buyer to accept delivery of a specified amount of a • Hedger, trying to protect themselves financial instrument in the allotted from the risk of changes in exchange time in the future. The main reason rates or interest rate by taking for the interest-bearing Trade positions in futures, which is the futures charging interest determined opposite of the risk they face. in securities.

• The speculators, they trade futures in • On-index futures price index futures the hope that it will make a profit decisively influence the current from price changes in the future. value of the index and the expected value of the index in the future.

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Table 1. Example futures contract

"Futures with delivery of the contract is Standardization of futures is caused to transferable standardized contract binding store them mainly takes place on the stock the buyer to pay the price on the maturity exchange, and less on the OTC market. The date of the contract, or binding the seller on most active futures exchanges in Sydney, that day to deliver the object of the contract. Hong Kong, Tokyo, Osaka, Paris, London, Futures without delivery of the object of the Singapore, etc. Operations in the futures contract is transferable standardized market is well regulated, whereby the contract binding the contracting parties degree of regularity varies from country to undertake to the maturity date of the country. Trade futures is largely regulated contract payment of the difference between in the United States on three levels: through the contract price and the price of the clearing houses and stock exchanges, via contract or on the maturity date. " 5 the National Futures Association and a commission to trade commodity futures. 2.2. FUTURES MARKET Participants in the stock trade futures. CHARACTERISTICS Futures traders can be classified in Basic characteristics of futures markets several ways. According to the general could be considered: classification, all futures traders may be:

• Standard object of trade, • traders on the floor and • Mainly trade, • merchants van parquet. • The adjustment, The traders on the floor include: local • Futures traders, and brokers and traders. • . Strategies are divided into: hedger, speculators and arbitrageurs speeders.

5 Hadži ć, M., Bankarstvo, tre će izmenjeno i dopunjeno izdanje, Univerzitet Singidunum, Beograd, 2009, str. 300. 54 www.japmnt.com (JPMNT) Journal of Process Management – New Technologies, International Vol. 4, No.3, 2016.

Under traders futures van stock represents the cost of withdrawal from the exchange parquet implied to thousands of contract. In this case the greater risk borne individuals and institutions (eg, banks, by the vendor options and from the base the financial intermediaries, investment banks, fact that the obligation to perform under the mutual funds, pension funds, etc.). contract what the customer requires it, regardless of possible unfavorable circumstance at a given moment on the 3. OPTIONS financial market. Option is any contract that one of the There are two types of options, such as: contracting parties have the right to buy or sell. Options give the holder the legal power 1) purchasing options, and that consists to do something, but not the obligation to do the same. So the option is 2) put options. the right but not the obligation to buy or sell an asset at a predetermined price by a In addition to the above types of specific date in the future. options that differ according direction which contain up the buyer or seller, we So, the options are securities that are distinguish between more and some other essentially specific in relation to the options, and depending on the selected forward and futures contracts or in relation criteria. In this sense, different options how to other financial instruments. Options still to use them and there is talk of European, fall into derivative securities that are American, exotic tip options, etc. Yet the nevertheless related to financial instruments most common classification options for the onset of the financial markets. according to the type of assets to which Organized trade options began more than they relate, so that a real difference to 40 years, namely in 1973 and the first in the financial, commodity and real options. US in Chicago when trading in these derivatives and reaches its peak. Sam root CONCLUSION of the financial derivatives linked to the first half of the XVII century, in Japan and With the use of financial derivatives, the Netherlands. And then, as a few which include forwards, futures and options centuries later option actually means the is the main motive of investors to prevent right but not the obligation to sell or to buy any possible risk in trading securities. The an asset according to predefined elements main essence of these agreements consists that relation on dates or prices. in the fact that in the case of these financial Accordingly, options are something more contract both parties are obliged to carry specific securities because they leave a out financial transactions in a pre-agreed choice to contract and do not realize, but time and according to the previously agreed what makes the main difference between price. Another important feature of options on one side and forwards and financial derivatives is that the parties do futures on the other hand is to be paid with not pay the premium even pay a the price which is optional title premium to commission which usually precedes the this so-called glass. "Conditional right" or signing of the contract, significantly the right to withdraw from the purchase reducing transaction costs or business is price and at a specified day. based on respect for fair business practices, It should make a difference between and more importantly, on respect for the the price of an option contract that is law governing the operations in the contracted (as the price at which a buyer financial markets. buys and the seller sells goods or assets on a certain day of the premium which 55 www.japmnt.com (JPMNT) Journal of Process Management – New Technologies, International Vol. 4, No.3, 2016.

In any case, one of the most important REFERENCE qualities of forward contracts is that this is a contract governing the future delivery of 1. Stoši ć Mihajlovi ć, Lj. Tržište, troškovi i assets and agreed in advance, or fixed price, cene, VTTŠ, Vranje, 2015. or whose collection falls on the end of the 2. Unkovi ć, M., Milosavljevi ć, M., contractual period to which it relates Savremeno berzansko I elektronsko forward. On the whole, futures arose after poslovanje, Singidunum, Beograd, str.85. the forwards. For them characteristically that comes strictly contracts or such that are 3. Hadži ć, M., Bankarstvo, tre će izmenjeno i not standardized, and they are assembled in dopunjeno izdanje, Univerzitet Singidunum, Beograd, 2009, str. 300. a form that is at the moment of the conclusion of adapting to the needs and 4. Šoški ć, D., Živkovi ć, B., Finansijska requests of the parties. tržišta, Beograd, 2010 . Futures contract and futures contract, represents an agreement between two parties to buy or sell assets in a known time in the future for a known price. Forward contract or the futures contract is an agreement between the two entities, the buyer and the seller, on the sale of certain assets - goods, which achieves to take delivery of these assets - goods and its final payment made in future. Both types of contracts are very important for stock exchange market. One of the most famous stock exchanges on which they are used are: • International Monetary Market (IMM) • The Chicago Board of Trade (CBOT) and • London International Financial Future Exchange (LIFFE).

It is important that remark forwards, futures and options as well as represent a very powerful instrumentation hedging and to the one on the basis of which the investors are trying to protect from very different types of risk. For example, just by using options such derivative securities can be reduced, if not completely eliminate the risk of price changes, fluctuations in market indicators, or from changes in interest rates, which in any case improve the position of investors in the market and so what reduces the risk.

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