Fundamentals of Futures - Market Operations RSS Feed

Electronic and Open-Outcry Trading

CME Group — Wed, 24 Sep 2008 10:57:00 EST

In the futures markets, contracts are traded “side by side,” both electronically and in the open-outcry exchange pits. Today, 80 percent of all futures trading is electronic.

1.Electronic trading has played an important role in the functioning of the fast-paced financial markets for many years. Its use in the financial services industry was extensive long before the dot com era and the adoption of e-commerce by other industries.
2.In open outcry, traders cry out bids and offers to each other on a trading floor. Even with open outcry, the prices and volumes of trades are entered into electronic systems for distribution to the wider markets.

Liquidity

CME Group — Wed, 24 Sep 2008 10:50:00 EST

Liquidity describes the sensitivity of price to trading.

1.A liquid market has small price changes in response to orders
2.A trader with a demand for an immediate trade in an illiquid market causes price to move significantly, though temporarily

Central Clearing: Counter-Party to Every Trade

CME Group — Wed, 24 Sep 2008 10:45:00 EST

Clearing houses play a key role in the stability and integrity of markets by managing clearing risk. Clearing risk covers:

1.Credit risk of counterparties
2.Market risk
3.Liquidity risk
4.Systemic risk

Mark-to-Market Daily Settlement

CME Group — Wed, 24 Sep 2008 10:39:00 EST

At the end of the trading day your futures position is marked to market, meaning the clearing house settles your account on a cash basis. Profits are added to or losses are deducted from your performance bond account balance. This rebalancing occurs at the close of each trading day.

Performance Bonds

CME Group — Wed, 24 Sep 2008 10:34:00 EST

A major difference between futures and stocks involves the concept of the performance bond:

1.Stock trading: a partial deposit on a transaction, borrowing the remaining from your broker
2.Futures trading: good faith deposit indicating your ability to fulfill the contract

Cross Margining

CME Group — Wed, 24 Sep 2008 10:20:00 EST

Cross margining significantly enhances both the efficiency and financial integrity of the clearing system by:

1.Allowing gains accruing to futures or options positions to be immediately available to meet the requirements for funds from losing positions
2.Linking across markets for exchange-traded equity derivative products to focus on true intermarket risk exposure (a single performance bond requirement across markets)

SPAN: Standard Portfolio Analysis of Risk

CME Group — Wed, 24 Sep 2008 10:04:00 EST

SPAN performs an analysis of the possible effects of changing market conditions on portfolios of futures and options to identify the appropriate performance bond level. Span has been widely adopted across the globe as the standard for risk analysis and performance bond establishment.

Settlement Options - Physical Delivery vs. Cash Settled

CME Group — Wed, 24 Sep 2008 10:03:00 EST

Instead of relying on physical delivery to achieve convergence, futures contracts employ a device called cash settlement. In the cash settlement procedure, all long contracts that remain outstanding after the last day of trading are automatically offset by CME Group.

All contracts are thus canceled and, via the normal performance bond system, money moves from losing accounts to profiting accounts, based on the final one-day price change – hence the term cash settlement. It’s as if all the remaining contracts were simply offset by open outcry on the last day of trading, and all at the value of the appropriate index.

Offsetting a Trade Position

CME Group — Wed, 24 Sep 2008 10:02:00 EST

Offsetting is entering an order to liquidate the initial position:

1.By selling if one is holding a long position
2.By buying if one is holding a short position

Financial Safeguards

CME Group — Wed, 24 Sep 2008 10:01:00 EST

Exchange-traded and cleared products have the following measures in place to protect each trader and trade:

1.Segregated customer funds (no commingling between trader account and firm account)
2.Extensive capital requirements for clearing members
3.Financial surveillance and regular audit

Regulating Futures Trading

CME Group — Wed, 24 Sep 2008 10:00:00 EST

Regulations were put in place a long time ago to keep the operation of the futures market free of market abuses and price manipulation. Both the federal government and the exchanges play an active role in regulating market activity.