EXCHANGING CONTRACTS END TRADING MECHANISM ON FUTURES MARKETS IN ROMANIA Candidate to Ph.

D Lecturer Gabriela Bologa AGORA University, Oradea gabriela_bologa@univagora.ro Student Maria (Agape) Roca AGORA University, Oradea Faculty of Law and Economics maria_rosca@yahoo.com Abstract: The ample and unanticipated oscillations of prices on the spot markets, together with the limited power of the participants on these markets, were favorable factors to the apparition of forward and futures transactions. The mechanism of transaction on the futures markets is being realized in special spaces arranged for this activity, places called rings or pits. The base rule on futures markets is to buy at low cost and to sell at high price, no matter in what order. Since their apparition, stock exchanges gained a special attention from the public, representing a hope for a quick enrichment, and the solution in searching a security for the near or distant future. The process of un materializing as the materials was the first step towards futures transactions. Facilitating the ascertainment of goods contributed to the development of active capital. Key words: spot contract, forward contract, futures contract. I. Exchanging contracts Since their apparition, stock exchanges gained a special attention from the public, representing a hope for a quick enrichment, and the solution in searching a security for the near or distant future. The process of un materializing as the materials was the first step towards futures transactions. Facilitating the ascertainment of goods contributed to the development of active capital. The ample and unanticipated oscillations of prices on the spot markets, together with the limited power of the participants on these markets, there were favorable factors to the apparition of forward and futures transactions. The spot contract its object is present merchandise, that exists at this point of closing a contract and that is going to be delivered and paid immediately. The forward contract it is private agreements to buy or to sell, to deliver or to pay at a certain future date some goods, currency or a financial asset at a rate (price) set at this point of closing the transaction. Futures contract - it is a standardized agreement to buy or to sell an asset, 12

some goods, financial title or monetary instrument at a rate (price) set at this point of closing the transaction and dissolution at a future date. Option contracts are contracts between a buyer and a seller that give the rights, but not the obligation to buy or to sell at a future date an asset, some goods, financial title or monetary instruments, the right obtained with the payment of the first tinge.

The spot contracts The spot contracts are sale contracts that take place, theoretically, immediately after closing them. They are executed between 24 hours and 10 banking days, and they must deliver the merchandise. The merchandise that stays at the base of spot contracts is: Seen (it exists); Available (it isnt involved in any obligations, for example: bond); Present (it is in a deposit agreed by the exchange). The strike price of the contract is set at the time of closing the deal.

Forward contracts Once the exchanges appeared, the sellers and the buyers had the possibility to reduce the uncertainty of the prices through a forward cash sale. A forward cash sale or a forward contract represent a private negotiation in which the seller and the buyer agree upon a price of the merchandise that is going to be delivered in the future. At forward cash contracts, the merchandise could not be sent until the pre established delivery date. Now, the seller and the buyer have the possibility to block a price long before the execution of the contract and to eliminate the uncertainty caused by the price fluctuations from this period. The certainty of the price offers the possibility to buyers and sellers to anticipate correctly the future incomes. The forward contract helped to reducing the risk of changing the price and facilitated the development of markets and selling the merchandise. However, the risk that a merchant (the buyer of the merchandise) not to execute the contractual stipulations in the case when the prices reduce dramatically didnt disappear, the producer remaining with the goods in stock and without other buyers. On the opposite case, if the prices increased dramatically in the period between closing the deal and delivery, the seller would have been tempted not to respect the contract trying to sell to another for a much higher price than the one set in the contract. To solve the problem of ensuring the execution of the transaction a new method developed. Each participant to a transaction deposit a sum of money to a third part, a neutral one. This thing ensures the security that each part will respect 13

the contract. If one of the parts doesnt obey the obligations, the other part will receive the money as a compensation for any financial loss. The exchanges developed for themselves standards of quality and measure units for each merchandise. This led to the marketing (selling and buying) contracts for merchandise securities that specified the quantity, quality, maturity date and delivery date of a merchandise. The most representative example of a forward contract used daily by every one is the subscription to a newspaper, for which it is collected a pre established price for the whole period of the subscription (contract). There are some advantages of forward contracts. Besides the obvious ones, as knowing the exact sum and quantity that is going to be received, the quality level and the delivery moment, the certainty of the price is important because the buyer will anticipate the costs. The seller will know beforehand the incomes. So, the certainty of the price gives the possibility to the buyers and the sellers to correctly anticipate the future incomes. Future Contracts. Appeared 100 years later, the futures contracts noted a fulminate expansion in the financial world at the end of XX century, the volume of transactions of these exceeding in the present world widely any other exchanging products. The explication of this state is a very simple one: through their nature, these futures contracts offers to the one who is trading them the possibility of substantial earnings through locking up a reduce sum of money. Of course, the risk taken in such a transaction exists, and it cannot be ignored. The bigger it is the chances of winning increase, on one hand, but also the chances of losing, on the other hand. The big diversity of these derived products (they are called this way because they have at their base an active support projections, interest rates, stock indexes, etc.) and especially their flexibility allows the investors not only substantial reducing the risk that is taken at trading such a product, and in some cases even avoiding it in some strategies well theorized and correctly applied in practice. Once the launching towards trading the first futures contract at the Monetary, Financial and Commodity Exchange Sibiu, in 1997, the investors from the Romanian financial market and all the Romanian businessmen have the possibility to take advantage of these offered products, regardless if their purpose is realizing some immediate profits or just protecting against the risks that float over their own businesses. The futures contract is a standardized agreement among two partners a seller and a buyer to sell and to buy a certain asset (projections, interest rates, financial and stock indexes), at a price set at the point of closing the transaction and with the execution of the contract at a future date called deadline. In other words, by this kind of contract, the seller commits himself to sell, and the buyer to buy the asset from the contract at a future date (deadline), but at a price set at the point of closing the deal. The advantages of futures contracts: 14

The futures contracts are standardized. The price changes daily in relation with the ration between demand and offer Differently from forward contracts, futures contracts have a secondary market.

Option contracts An option contract represents a right, bunt not an obligation to buy (an option CALL) or to sell (an option PUT), a financial asset (a share, a futures contract, etc.) at a future moment and at a price set in the present (called strike price). The buyer of the option contract can decide if he will exert or not the option of buying or selling the asset, relating his own interests and projections. For this right of option, the buyer must pay the seller at the point of closing the deal a sum of money called a bonus. The value of the bonus is that negotiated at the exchange, and it is the object of demand and offer. So, the buyers loss is limited at the bonus that he is paying to the seller of the contract. If his predictions dont confirm, the buyer is not obliged to exert his option, losing only the bonus. If his predictions confirm, the buyer will exert his option. For the sellers part, the earning is the bonus collected from the buyer, the seller doesnt have any decisional power to exert the option, he is going to wait for the buyers decision on this matter. II. Futures market and option market

In the operations executed on futures market a series of specific terms are used and the participation on this market expects knowing them. The terminology used in futures A bull market or the markets under the sign of the bull represent the market in which the prices are increasing. When a market is called bullish, there is a perspective that the prices will increase. A bear market or the markets under sign of the bear represent the market in which the prices are decreasing. Therefore, a bearish market gives a pessimist perspective and the operators consider that the prices are decreasing. The long position: if a futures contract is bought, the buyer has a long position. The operator initiates long positions when a future increasing of the futures price is expected. The hedger will initiate long positions when it is exposed to the increasing of the price of the asset. The short position: somebody who will sell futures contracts that he didnt previously have is short, or he has open short positions. This concept is not to be confused with the one in which somebody who initially had a long position by buying some futures contracts, and then he sells them to compensate his position on the market. The operator initiates short positions when he anticipates the 15

decreasing of the futures price. The hedger initiates short positions when he is exposed to the decreasing of the price of the merchandise or of the asset. The marking at the market of futures contracts makes that the account is daily credited and debited, relating to the evolution of the price of the open positions. The loss or the profit, resulted by marking the market makes that the sum existing in the account to oscillate, but this cannot decrease under the level of the safety margin. The appeal in margin: the situation in which the sum from the margin account decreases under the level existing in the account, the holder of the account (name of account) receives an appeal in margin for the difference between the initial level of the margin and the sum existing in the account. The holder has to respond with adding funds until the beginning of the next trading session, so all the naked position are sold out forcibly until the sum from the account reaches the initial level of the margin. The delivery of the merchandise or of the currencies to the exchanges around the world is optional. In USA, 98% of the futures contracts are sold out on the market and only 2% have as a result physical delivery or selling out the merchandise. For some futures contracts, as those for synthetic articles a stock index, currency index there isnt a possibility of physical delivery. The positions are closed by selling out and paying the differences. Symbols and specifications The futures contracts can be realized through many units of trading and thats why the exchange practice imposed the simplification of the names through symbols. So, the next symbols were adopted: 1) Futures contract on American dollar, symbol: ROL/USD 2) Futures contract for European currency, symbol: ROL/EURO 3) Futures contract for the stock index, BVB called BET, symbol BET (ROL) Similarly, symbols for other trading units can be adopted. The trading unit represents the assets from the contract such: ROL/USD = 1.000 USD ROL/EURO = 1.000 EURO BET (ROL) = 10.000 ROL multiplied with BET index in points. The value of the futures contract: it is obtained by multiplying the futures price at which the transaction was closed with the last trading unit. The step of the futures contract is represented by the minimum fluctuation that can modify the price quotation, and it refers to an up and down movement of the price of the support asset. The step is that of 1 ROL for futures contracts ROL/USD, ROL/EURO and of 0.1 points for the contract on stock index BET and the options having futures contract as a support on BET index. The limit of daily oscillation of the price is determined by the exchange, and it represents the oscillation of the previous day that can be admitted. The initial margin is the value that the name of account must have in the margin account at the initiation of each contract. The value of the margin is set by 16

the exchange after consulting the house of compensation and any other situation of destabilization of the market, is immediately applied. The maintenance margin is the element that ensures the integrity of the house of compensation and the broker agency. The maintenance margin represents the minimum sum that the name of account can have in the margin account to maintain naked positions for futures contracts, and it represents 3 from the initial margin. III. The trading mechanism on futures markets The trading mechanism of futures markets is realized in places specially arranged for this activity, places called rings (pits). In our country, at BMFM Sibiu, the trading took place in rings taking into account the trade assets. However, in 2000, BMFMS introduced the electronic system of trading of futures and option contracts. The new system represents a national premiere, and it is available from the distance too, from any part of the country. The new software SAGGITARIUS was created integral by the department of informatics and trading af the Exchange and Romanian House of Compensation, bring more premiers. The most important novelty is represented by the replacement of the margin system with an evaluation system of the risk that takes into consideration all the naked positions of a futures or option contract. Relating to this, the risk of a contract is evaluated, that can reach to zero. The base rule in futures markets is to buy at a low price and to sell at a high price, regardless the order. Trading orders All the trading on this market is realized on the base of some pre established orders of the clients of the societies of exchange. There are three types of fundamental orders: selling order, buying order, spread orders. However, these orders vary in many categories. Relating to the validity of an order: orders valid one day only and orders with validity set by the investor; relating to the price of the transaction there are two types of orders: price market orders and set price orders. Market order given to the agent to realize immediately a transaction at the price market that is going to be at the point of execution, this being the best price. Limit orders divide themselves in two categories at limit and stop limit and each of them can be bought or sold. Spread order represents the order of buying a futures contract and to sell simultaneously another futures contract on the same merchandise or a similar one, at a different price. These types of spread orders gave birth to some types of special transactions called spread transactions. Spread transaction is realized by buying and selling simultaneously two related futures contracts. This type of transaction is initiated hoping that the difference of price among the two contracts will be changed in its profit before compensating the transaction. The difference between the contracts is called spread. Lets suppose that, following the spread among the contracts, we expect that the prices of the futures contracts for dollars and euros to grow, but not the same. So, we think that the 17

spread among the two contracts will be modified. We could buy the contract of which growth we estimate to be higher (euro) and to sell the other one (dollars). This means to use a spread transaction. Lets suppose that the euro price grows bigger. When we close the spread transaction, we will obtain more money by selling the euro contracts than by losing from re-buying the dollar contracts. The profit obtained by this transaction is equal with the changing of the spread among the two contracts, shown in the below drawing by the grey colored zone.

BIBLIOGRAPHY:

1. Ceresoli M. , Guillaud M. Gestion financiere de la banque, ESKA, Paris, 1992, p. 9; 2. Korten D. The corporations lead the world, Antet Publishing House, 1997; 3. Stoica Ovidiu Capital markets mechanisms and institutions, Economic Publishing House, Bucharest, 2002; 4. Teulon Frederic Capital markets, European Institute Publishing House, Iai, 2001 5. Oxford Reference A Concise Dictionary of Business, Oxford University Press, Oxford, 1992 www.bvb.ro

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