Copy (2) of Futures Market Trading Mechanism-1

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Futures Market Trading Mechanism • Futures contract is an agreement between two parties to buy or sell an asset at a certain futures time for a certain price. Futures contract are traded on recognized stock exchanges .Since the value of a futures contract is derived from the value of the underlying asset ,hence they are called derivative instruments .If the underlying assets are financial instruments then these will be called as financial 2

Futures trading refers to entering in to contracts to buy or sell financial assets or commodities for futures delivery as settlement on standardized terms.

• The general mechanism in which the exchange organize the trading of futures contracts are • Specification of contracts • The operation of margin accounts • Delivery/settlement of contracts • The organizations of exchanges • The regulations of markets • The ways in which quotes are made . 3

Here we discuss the mechanism of futures trading in general and popular all over the world rather of a particular exchange .Here in the table we show a list of imp. exchage in USA which trade futures and their assets/commodities. LIST OF EXCHANGES

FINANCIAL ASSETS AND COMMODITIES

Chicago Board of Trade (CBOT)

Grains ,oil seeds ,metals ,financials

Chicago Mercantile Exchange Division (CME)

Live stock ,Meat ,financials ,wood

International monetary market (IMM)

do

Index and Option Market (IOM)

do

Coffee , sugar and Cocoa Exchange (CSCE)

Food and fibre , financials

Commodity exchange Inc (COMEX)

Metals , Financials

New York mercantile Exchange

Metals, petroleum, food and fibre 4

Kanas City Board of Trade (KCBT)

Grains ,Financials

Mid America Commodity Exchange (Mid Am)

Grains and oil seeds ,live stock ,meat, metals ,financials

Minneapolis Grains Exchange (MGE)

Grains

New York cotton Exchange Division Financial Instruments Exchange (FINEX)

Food,and fibre ,financials

Chicago Rice and Cotton Exchange (CRCE)

Food and Fibre

Philadelphia Board of Trade Financials

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Mechanism 1 Specification of futures contracts • All the futures contracts are initiated through a particular exchange (as it is shown on the table) • When a new futures contract is developed ,an exchange must specify in some detail the exact nature of some contract of the agreement between the two parties . • Further it must specify the underlying asset ,how price will be quoted ,size of the contract ,when and where delivery will be made ,how price will be determined /fixed . 6

Before a future contract coming to registration at an exchange ,first the trader willing to buy or sell futures will have a contract a broker. • That broker must be a registered broker who is authorized to trade on the floor of an exchange on behalf their clients or customers. • Customers open their account with the broker member who in turn looks that the order is executed on the floor of an exchange . • He collects margin money from customer ,maintain customer money balances ,record all the financial details and report all trading activities of the customers . 7

Stock Exchange Normally Performs three functions • They provide a physical market place known as “The floor” where future transactions are

sold ,and purchased by the members of exchange .The exchange maintains the floor . • They maintain and enforce ethical and financial norms applicable to the futures trading undertaken on the exchange • They promote business interests of members

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Members may be individuals or organizations .Membership is limited to a specific number of seats . Each member has the right to carry on trade on the exchange ,provided that they must abided the rules ,norms of exchange There are two basic objectives to buy a seat on the exchange – 1) to engage in floor trading activities 2)to get the rights as per the exchange’s norms ,to execute futures ,trades without playing the commission to the broker . 9

Futures contracts are traded in trading pits on the floors of the exchange s only during official trading hours .

• Traditional style of trading in futures is called open outcry system . • There are different type of order in futures trading by a customer to the broker .They are market order ,limit order ,stop order ,stop limit order ,scale order ,contingent order ,and spread order .We will discuss it one by one . 10

Market Order • The investor is prepared to trade at the current market price .It means they place a market order with their broker and then these are passed on to the commission representing the two side( buyer and seller) • Limit Order – Customer specifies a certain price and requests that the transaction be executed only at a specified price or better one is obtained ,otherwise not . • In this way the trade is finalised when two tader agree to take opposite sides of contract ,given price for a specified quantity at a futures period 11 specified .

Stop Order • Here the investor informs the member /broker to trade at any price once the market price has reached a certain level .At that point the broker will execute the order regardless of whether the price is above ,below or equal to the stop price .So stop order will sure ti be executed once the stop price has been reached . Stop order are used to protect losses ,preserve profits and take new positions .In market buy a stop order means stop prices above the current market price and sell stop order means stop prices below the current price . 12

A stop limit order • It is just like a stop order where the investor instructs the broker to enter in to a position after the market price has reached at a certain level .The limit price may or may not be equal to the stop price . • For example an investor who took the long position of SBI share at Rs.400.00 may instruct his broker to sell if the future prices falls to Rs 390 but to accept not less than Rs.380 13

Alternative Order • Here the investor can put two orders but wants only one to be filled up ,which limits the potential profit order .For example ,the customer who entered a long position for SBI share at Rs. 350 may instruct the broker to sell if the price either increase to Rs.360 or falls to Rs 340 . • An contingent order -The broker is asked to take a certain position if the price of another contract reaches a given level • Spread Order - Specifies the broker to take a spread position composed of opposite position in similar contract . 14