22: Futures Market

Question 1

Forward/Futures Contract Definition

Answer 1

An agreement calling for future delivery of an asset at an agreed-upon price.

Question 2

Futures Price Definition

Answer 2

The price at which the futures trader commits to make or take the delivery of the underlying asset.

Question 3

Long Position Definition (Futures)

Answer 3

The futures trader who commits to buying the underlying asset.

Question 4

Short Position Definition (Futures)

Answer 4

The futures trader who commits to selling the underlying asset.

Question 5

Single-Stock Futures Definition

Answer 5

Futures contracts on a single stock instead of a broad-based index.

Question 6

Clearinghouse Definition

Answer 6

Facilitates transfer of securities. For options and futures contracts, acts as the middleman between two traders.

Question 7

Open Interest Definition

Answer 7

The number of outstanding futures contracts.

Question 8

Margin Definition

Answer 8

An established value below which a trader’s margin cannot fall.

Question 9

Convergence Property (Futures) Definition

Answer 9

The meeting of futures prices and spot prices at the maturity of the futures contract.

Question 10

Cash Settlement Definition

Answer 10

The provision of some futures contracts that requires settlement according to the monetary value of the underlying asset as opposed to delivery.

Question 11

Basis Definition

Answer 11

The difference between the futures price and the spot price at time t.

Question 12

Basis Risk Definition

Answer 12

Attributable to uncertain movements in the spread between the futures price and the spot price.

Question 13

Calendar Spread Definition

Answer 13

Buy one option and write another with a different expiration date.

Question 14

Spot-Futures Parity Theorem

Answer 14

Describes the theoretically correct relationship between spot and futures prices. Violation allows arbitrage.

Question 15

Marking to Market Definition

Answer 15

Daily settlement of obligations of futures positions.

Question 16

Describe the positions of two traders in a futures contract.

Answer 16

The long position buys the underlying asset and the short position sells it.

Question 17

How can a trader in the long position of the futures contract make a profit?

Answer 17

If the price of the asset at the maturity of the contract exceeds the future price because they are getting it at a discount.

Question 18

How can a trader in the short position of the futures contract make a profit?

Answer 18

If the price of the asset at the maturity of the contract is less than the futures price because the trader is selling it at a higher price.

Question 19

If the price of an asset exceeds the futures price at the maturity date, does the short or long position profit?

Answer 19

The long position profits.

Question 20

If the price of an asset is less than the futures price at the maturity date, does the short or long position profit?

Answer 20

The short position profits.

Question 21

What is the difference between futures and forwards contracts?

Answer 21

Futures contracts are more standardized. Futures contracts involve marking to market, in which gains and losses are settled daily, whereas forwards contracts involve no cash transfers until maturity.

Question 22

What is the benefit of standardization of futures contracts?

Answer 22

Increased liquidity because there are many options for buyers and sellers.

Question 23

How do you calculate the long position’s gain or loss?

Answer 23

P_T - F_0
Where P_T is the spot price at time T and F_0 is the original futures price.
The long position makes a gain if the spot price exceeds the original futures price at time T.

Question 24

How do you calculate the short position’s gain or loss?

Answer 24

F_0 - P_T
Where P_T is the spot price at time T and F_0 is the original futures price.
The short position makes a gain if the original futures price exceeds the spot price at time T.

Question 25

How do speculators use futures contracts?

Answer 25

Speculators use futures contracts to bet on the ultimate price of an asset.

Question 26

How do short hedgers use futures contracts?

Answer 26

Short hedgers take short positions in futures contracts to offset any gains or losses on an asset they already own.

Question 27

How do long hedgers use futures contracts?

Answer 27

Long hedgers take long positions in futures contracts to offset any gains or losses on the purchase price of an asset.

Question 28

How can a trader use futures contracts to hedge risk on an asset they already own?

Answer 28

The trader can take the short position to offset any gains or losses on their asset.

Question 29

How can a trader use futures contracts to hedge risk on an asset they are purchasing?

Answer 29

The trader can take the long position to offset any gains or losses on the purchase price.