Shiee Chimanbhai Patel institute of management & Reseaich Page

Futures and Options on Futures

History
1he 1
sL
exchanges were organlzed ln Chlcago because Lhe MldwesL was a
ma[or producer of agrlculLural producLs and Lhus Chlcago was a ma[or cenLer
for Lradlng agrlculLural producLs and many processlng planLs and warehouses
for agrlculLural producLs were locaLed Lhere
1he Ch|cago 8oard of 1rade (C8C1) was Lhe 1
sL
organlzed exchange for graln
1he Ch|cago Mercant||e Lxchange (CML) sLarLed ln 1874 as Lhe Chlcago
roduce Lxchange Lhen renamed lLself Lhe Chlcago 8uLLer and Lgg 8oard
because LhaL was whaL was llsLed on Lhe exchange As Lhe number of
commodlLles Lraded lncreasedlncludlng hldes onlons and poLaLoeslL was
lnevlLable Lhe exchange would adopL lLs presenL more general name ln 1919
C8C1 and CML are ln Lhe process of merglngLhe comblned exchanges wlll be
named Lhe CML Group
luLures for frozen pork bellles began Lradlng ln 1961 Lhe 1
sL
year fuLures on
sLored meaL was Lraded Llve caLLle was added ln 1964 whlch was Lhe 1
sL

fuLures conLracL for llve anlmals
ln 1972 Lhe CML lnLroduced flnanclal fuLures LhaL conslsLed of 8 currency
fuLures 1he 1
sL
cashseLLled fuLures conLracLCML Lurodollarwas
lnLroduced ln 1981 1he esLabllshmenL of cash seLLlemenL raLher Lhan physlcal
dellvery allowed Lhe fuLures markeL Lo expand lnLo producLs LhaL elLher can'L
be dellvered or would be dlfflculL Lo dellver physlcally such as fuLures based
on sLock lndexes such as Lhe S 300 sLock lndex LhaL was lnLroduced ln
1982 Cfferlng cashseLLled fuLures ls slmply ellmlnaLlng Lhe unnecessary
componenL of physlcal dellvery for mosL Lraders whlle provldlng Lhe 2
lmporLanL quallLles of fuLures Lhe ablllLy Lo hedge porLfollos and Lo proflL from
speculaLlon
1oday lLs dlverslLy of producLs lncludes agrlculLural commodlLles forelgn
exchange producLs lnLeresL raLe producLs equlLy producLs largely based on
ma[or lndexes a|ternat|ve |nvestment products whlch lncludes energy
weaLher economlc derlvaLlves and houslng lndex producLs and 1kAkkS
(1ota| keturn Asset Contracts) whlch are based on commodlLles euro
currency and gold for lnsLance
Shiee Chimanbhai Patel institute of management & Reseaich Page

#egulation
1he fuLures markeL ls regulaLed ln Lhe unlLed SLaLes by Lhe Secur|t|es and
Lxchange Comm|ss|on (SLC) Lhe Commod|ty Iutures 1rad|ng Comm|ss|on
(CI1C) Lhe Nat|ona| Iutures Assoc|at|on (NIA) and by Lhe exchanges
Lhemselves 1he Cl1C creaLed by Lhe Commod|ty Iutures 1rad|ng
Comm|ss|on Act of 1974 ls a federal agency LhaL regulaLes all fuLures Lradlng
ln Lhe unlLed SLaLes and oversees Lhe nlA 1he exchanges musL obLaln
approval for any regulaLory changes and for Lhe lnLroducLlon of any new
fuLures or opLlons on fuLures All fuLures exchanges musL have Lradlng rules
conLracLs and dlsclpllnary procedures approved by Lhe Cl1C
1he nlA a selfregulaLory agency creaLed by Sect|on 17 of Lhe Commod|ty
Lxchange Act of 1981 regulaLes Lhe acLlvlLles of lLs members whlch lncludes
any brokers Lradlng fuLures and Lhelr agenLs nlAs responslblllLles lnclude
screenlng LesLlng and reglsLerlng persons applylng Lo conducL buslness ln Lhe
fuLures lndusLry nlA and Lhe exchanges have responslblllLy for audlLlng and
enforclng compllance wlLh lndusLry rules such as flnanclal requlremenLs
segregaLlon of cusLomers funds accounLlng procedures sales acLlvlLles and
floor Lradlng pracLlces
Iutures Contract
A fuLures conLracL's speclflcaLlon deLalls (also called contract specs) lnclude
Lhe Lype quallLy and quanLlLy of Lhe underlylng asseL or commodlLy monLhs
Lraded dally llmlLs mlnlmum Llck lncremenLs Lradlng hours and oLher deLalls
unlque Lo each producL All conLracL specs can be found onllne aL Lhe exchange
Lradlng Lhe conLracL
1he underlylng asseLs of fuLures conLracLs are agrlculLural commodlLles
meLals and mlnerals energy such as oll and coal currencles and whaL are
called flnanclal fuLures flxedlncome securlLles and sLock markeL lndexes
llnanclal fuLures are by far Lhe largesL markeL for fuLures

Lxamp|e of contract deta||s for 2 butter futures and 1 opt|on on
butter futures

Source Ch|cago Mercant||e 8ank
Shiee Chimanbhai Patel institute of management & Reseaich Page

CML 8U11Lk IU1UkLS
1rade unlL 40000 pounds of Crade
AA buLLer
SeLLle MeLhod hyslcally dellvered
olnL descrlpLlon 1 point $.0001 per
pound $4.00
ConLracL Six months oI March,
May, July, September,
October, and December.
LlsLlng CurrenL llsLlng
roducL
Code
ClearingDB
TickerDB
1radlng venue floors
Pours 9:30 a.m. to 1:10 p.m.
LTD (12:10 p.m. II the
LTD is on a day
that the market closes
early, then the time is
11:10 a.m.)
llsLed All llsLed monLhs
llmlLs $0.05/lb, 500 pts, $2000
Expandable price limits,
see Rule 1202.D
Mlnlmum flucLuaLlons Regular
0.00025$10.00


Shiee Chimanbhai Patel institute of management & Reseaich Page

CML 8U11Lk C1ICNS

1rade unlL
One Butter Futures
Contract
olnL
uescrlpLlons
1 point $.0001 per pound
$4.00
ConLracL
Mar, May, Jul, Sep, Oct,
Dec and Flex Options.
LlsLlng Current Listings
SLrlke rlce lnLerval
Cents per pound at $0.02
intervals (i.e., 1.20, 1.22,
1.24)
roducL
Code
ClearingDB
TickerDB
1radlng venue Floor
Pours
9:30 a.m.-1:12 p.m. LTD
(12:10 p.m.)
LlsLed All listed series
SLrlke All listed intervals
Mlnlmum
llucLuaLlon
Regular
0.00025$10.00

Cab
0.000125$5.00




Shiee Chimanbhai Patel institute of management & Reseaich Page

CML CashSett|ed 8utter Iutures
1rade unlL
20000 Llmes Lhe uSuA
monLhly welghLed average
prlce per pound ln Lhe uS
for Crade AA 8uLLer
SeLLle MeLhod Cash SeLLled
olnL
uescrlpLlons
1 polnL00023 per pound
$300
ConLracL
12 consecuLlve calendar
monLhs
LlsLlng CurrenL LlsLlngs
roducL
Code
ClearlngC8
1lckerC8
1radlng venue CML Clobex
Pours
930 am110 pm (1210
pm L1u)
LlmlLs
$03 per pound expanded
Lo $10 per pound afLer
one day llmlL move
no llmlLs durlng lasL 3 days
of Lhe explrlng conLracL
monLh
Mlnlmum
llucLuaLlon
8egular
000023$300


Shiee Chimanbhai Patel institute of management & Reseaich Page


ll u 1nlNk 1nl5 u414 l5 u5luL u M4Y
lNcLuu l15 uP1O u
Cpt|on Markets
CpLlon and fuLure conLracLs are boLh derlvaLlve securlLles whlch play a
large and lncreaslngly lmporLanL role ln flnanclal markeLs 1hese are securlLles
whose prlces are deLermlned by or derlve from" Lhe prlces of oLher
securlLles 1hese asseLs are also called conLlgenL clalms because Lhelr payoffs
are conLlgenL on Lhe prlces of oLher securlLles
1radlng of sLandardlsed opLlons conLracLs on a naLlonal exchange sLarLed ln
1973 when Lhe Chlcago 8oard CpLlon Lxchange (C8CL) began llsLlng call
opLlons 1hese conLracLs were almosL lmmedlaLely a greaL success crowdlng
ouL Lhe prevlously exlsLlng overLhecounLer Lradlng ln sLock opLlons CpLlon
conLracLs are Lraded now on several exchanges 1hey are wrlLLen ln commen
sLocks sLock lndexes forelgn exchange agrlculLure commodlLles preclous
meLals and lnLeresL raLe fuLures
1he Cpt|on Contract
A call opLlon glves lLs holder Lhe rlghL Lo purchase an asseL for a speclfled
prlce called Lhe exerclse or sLrlke prlce on or before some speclfled
explraLlon daLe 1he holder of Lhe call ls noL requlred Lo exerclse Lhe opLlon
1he holder wlll choose Lo exerclse only lf Lhe markeL value of Lhe asseL Lo be
purchased Lo be exceeds Lhe exerclse prlce



CpLlon And fuLure ConLracLs are boLh derlvaLlve securlLles
Shiee Chimanbhai Patel institute of management & Reseaich Page

$tock options give the option holder the right, but not the obligation, to buy or sell particular
stocks Ior a particular price, called the strike price, within a speciIied time. Options (also
called contingent claims) are derivatives, so called because their value derives Irom other
securities (called the underlying security, or just underlying or underlier), which in the
case oI stock options are particular stocks. They are used extensively Ior hedging because
options allow an investor to protect a position Ior a small cost, and speculators like them
because their proIit potential is much greater than the underlying securities.
Besides common stock, there are also options Ior stock indexes, Ioreign exchange,
agricultural commodities, precious metals, and interest rate Iutures.
Although options were originally traded in the over-the-counter (OTC) market, where the
terms oI the contract were customized or negotiated, option trading really took oII when the
Iirst option exchange, the Chicago Board Options Exchange (CBOE) was organized in
1973 to trade standardized contracts, which greatly increased the market and liquidity oI
options. Options trading began on April 26, 1973, with 1.1 million contracts traded that year.
Trading volumes have increased substantially since then:
O 1981: 100 million
O 2004: 1 billion
O 2006: 2 billion
everage is the Fundamental Advantage of Options
everage is the Iundamental advantage oI options. A small investment can beneIit Irom the
price movements oI securities that would either cost much more to own outright, or would
require a much greater risk. For instance, to buy 100 shares oI a $50 stock would require a
$5,000 investment, but to buy 1 call contract Ior 100 shares oI that same stock at $5 per share
would require a $500 investment. It is because oI leverage that options are excellent Iinancial
instruments Ior hedging a long or short position, or Ior pure speculation.
OI course, options have a downside; otherwise, why would anyone bother buying the
underlying security. Although the risk is limited to the premium Ior the option holder, the
disadvantage oI buying options is that they can expire completely worthless, and oIten will. II
the stock price does not move suIIiciently in the right direction beIore the expiration date,
then the investor loses the entire investment.
Example-The Profit Advantage of Options, and the #isk
On October 6, 2006, an April 2007 call to buy MicrosoIt stock Ior the price oI $30 (October
6, 2006 stock price: $27.87) was selling Ior .80 per share. Thus, 1 call contract to buy 100
shares oI MicrosoIt stock would cost $8.00. To buy 100 shares oI MicrosoIt stock would cost
$2,787.00! Since MicrosoIt is coming out with OIIice 2007 and Windows Vista, let's say the
price rises to $40 per share by April, 2007. The call contract would allow the holder to buy
100 shares oI MicrosoIt stock Ior $30, which could then be sold Ior $40 in the market. That's
a proIit oI $10 per share, or $1,000 per call contract, which equals 12,500 ($1,000/$8), over
the original investment oI $8 Ior the call contract, in the span oI about 6 months. It would be
virtually impossible to even approach getting the same return on investment buying the stock
itselI! An investor who bought the stock instead oI the call would have a proIit oI only 144
($40/$27.87) in the same time period. OI course, iI MicrosoIt's stock price didn't increase
Shiee Chimanbhai Patel institute of management & Reseaich Page 8

above $30 per share by the expiration date in April, 2007, then the call contract would expire
completely worthless, while the stock holder would still have the stock, and could receive
dividends on it. In Iact, according to the Options Clearing Corporation), about 30 oI all
options expire worthless every month.
The Option Contract
Option Contract
O &nderlying Security
O Call or Put
O American or European Style
O Strike Price
O Expiration Date
O umber oI Shares
(or other Multiplier
usually 100)
The elements oI a standardized option contract speciIies whether it is a put or call, its style as
to when the option can be exercised, the underlying security, the number oI shares oI the
underlying security Ior each contract, which is almost always 100 shares Ior equity options,
the strike price, and the expiration date.
Calls and puts are the 2 types of options. A call gives the holder the right, but not the
obligation, to buy a speciIic security Ior a set price, called the strike or exercise price. A put
gives the holder the right, but not the obligation, to sell a particular security Ior the strike
price.
Depending on the price oI the underlying security, option strike prices are set at $2.50, $5 or
$10 intervals, and most options are created and traded with price increments a little above and
a little below the current market price oI the underlying security.
II the price oI the underlying security moves substantially beIore expiration dates, then new
options are created with strike prices closer to the new market price oI the underlying
security. The older contracts are then exercised, closed out, or leIt to expire.
There are 3 styles oI options that diIIer as to when the option can be exercised. American
options allow the holder to exercise the option at any time beIore expiration, whereas
European options allow the holder to exercise only Ior a short time beIore the expiration
date. All equity options are American-style options, but most Ioreign currency options and
CBOE stock index options are European-style options. ote that, although European-style
options can only be exercised during a brieI time right beIore expiration, the options can be
sold beIore then. Most options that require a cash settlement instead oI the delivery oI
securities are European-style options, because it makes no sense to exercise an option Ior
cash when it can simply be sold Ior cash. The capped-style option can only be exercised Ior
a speciIic time beIore expiration, unless the underlying security reaches the cap price, in
which case, the capped-style option is exercised automatically. This cap limits the proIit
potential oI the option Ior the holder and the risk Ior the option writer.
Shiee Chimanbhai Patel institute of management & Reseaich Page 9

A standardized option contract is always Ior 100 shares oI the underlying security, unless it
is adjusted Ior a stock split, or some other event that would aIIect the relationship oI the
option to the underlying security.
Options always expire on the Saturday Iollowing the 3
rd
Friday oI the expiration month,
although they must be exercised by the Friday beIore expiration since that is the last trading
day. There are at least 2 near-term options which expire in the nearest 2 months, and there
are 2 long-term options. When the current month's options expire, then more are created that
expire in the month aIter the next. Example: when January options expire, then more options
are created that expire in March, so that the 2 near-term options will expire in February and
March.
The expiration dates oI long-term options are based on speciIic sequences. The exact months
oI expiration are based on 3 diIIerent sequential cycles: the 1anuary $equential Cycle, the
February $equential Cycle, and the March $equential Cycle. For larger companies and
major indexes Ior which there is a signiIicant market demand, there are also EAP$ (ong-
Term Equity AnticiPation $ecurities), which are special options that initially have expiration
dates several years into the Iuture, and always expire in January. Generally, there are 2 series
oI LEAPS that expire in the 2 January's Iollowing the long-term options.











Futures and Options on Futures
Shiee Chimanbhai Patel institute of management & Reseaich Page

Farming is a risky venture. A lot oI money, time, and eIIort is needed to produce Iarm
products, with many risks, such as weather or price Iluctuations in the market, which can
result in high or low prices in the spot market (aka cash market), which is the market where
the buyer pays cash to the seller Ior the immediate delivery oI the commodity. Since the
Iarmer can only sell in the spot market when the product is ready Ior delivery, there is no way
to know beIorehand what the price will be, and the same is true Ior the buyerboth have
price risk.
The spot market is a zero-sum tradeiI prices are too high or too low, either the buyer or the
seller proIits at the expense oI the other. Thus, iI grain prices rise, Iarmers beneIit, but millers
suIIer because they have to pay higher prices Ior their grain. II prices Iall, then Iarmers suIIer,
but millers beneIit. Forward contracts became common in the 1800's to protect both the buyer
and the seller by agreeing to a set price ahead oI time.
A forward contract (sometimes called a cash forward sale) is a contract to supply a
commodity at a given date Ior a speciIied price. o money is paid until the date oI delivery.
BeIore the organized exchanges, Iorward contracts were signed where Iarmers happened to
be selling their goods, such as Iarmer`s markets, public squares, and street curbs. But there
were 3 main problems with individual Iorward contracts:
1. there was a risk oI deIault by the other party, especially iI prices were either
extremely high or low by the delivery date, which negated the main value oI a
Iorward contractprice certainty;
2. the only way to legally terminate a contract was by mutual agreement, which would
be unlikely when the market price was signiIicantly diIIerent Irom the delivery price;
3. there was no easy way to resell the contract, because it had customized terms that
speciIically suited the seller and buyerhence, Iorward contracts were highly illiquid.
Eventually, organized exchanges developed that solved these basic problems. To lower the
risk oI deIault, the exchanges required that money be deposited with a 3
rd
party to ensure the
perIormance oI the contract.
The exchanges also standardized the contracts by stipulating the types oI contracts that they
would sell, including its terms. Standardized contracts were easier to sell or to oIIset with
another contract that eliminated the liability oI the original contract. Standard speciIications
include the amount oI the commodity, the grade, and delivery dates. These standard Iorward
contracts were called futures, and the exchanges developed listings Ior these contracts that
greatly increased their liquidity.
More recently, Iutures were created based on assets completely diIIerent Irom agricultural
products, such as stock indexes, interest rates, and even the weather, and provided more
investment opportunities Ior many more investors. They became great tools to hedge
portIolios or to simply proIit Irom speculation.
The buyers and sellers oI Iutures can be classiIied as hedgers or speculators. Hedgers use
Iutures to minimize risk, like the Iarmers who use Iutures to guarantee a price Ior their
product, or a miller who wants a set price Ior grain when it is harvested. Futures can also be
used to hedge investment portIolios. Thus, Iutures is a signiIicant means oI price risk
transfertransIerring price risk to someone with an opposite risk, or to a speculator who is
willing to accept risk to make a proIit.
Shiee Chimanbhai Patel institute of management & Reseaich Page

$peculators use Iutures to make a proIit, by buying low and selling high (not necessarily in
that order). The speculator has no intention oI making or taking delivery. A speculator is
making a bet on the future price of a commodity. II he thinks the price oI the commodity will
drop, he takes a short position by selling a Iutures contract. II he thinks that the price oI the
commodity will increase, then he takes a long position by buying a Iutures contract. Later, he
will close out his position by oIIsetting the contract. II he sold short, he will buy back the
contract, and iI he bought long, then he will sell the contract.
Short's
ProIit/Loss

Long's
Loss/ProIit
The buying and selling oI Iutures contracts is a zero sum gain, because it is basically a
contract between 2 traders. It is not an investment in a company that creates wealth, where
every shareholder can winor lose. II the short side proIits, the long side loses an equal
amount, and vice versa.
The number oI assets on which Iutures are based has greatly increased. In Iact, most Iutures
contracts today are Iinancial Iutures, which have nothing to do with Iarming or agricultural
products, and Iutures continue to expand in diversity.









Llnks used
hLLp//LhlsmaLLercom/money/fuLures/fuLureshLm





Shiee Chimanbhai Patel institute of management & Reseaich Page