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The futures markets: 45 questions and answers

The questions from the The futures markets course, each with the correct answer and a short explanation. Learn the topic step by step in the Unicorn Academy app.

1. What a futures contract is

What does a futures contract establish?

An exchange on a future date at a price fixed today The price is fixed today, the exchange takes place at expiry.

How does a future differ from an option?

It is an obligation for both parties An option gives a right, a future creates an obligation.

For which goods were futures created?

For agricultural products They served to fix the price of harvests in advance.

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2. Standardisation and the exchange

What do the parties to a future negotiate?

Only the price Everything else is set by the exchange.

What is the advantage of standardisation?

You can get out by selling an identical contract The contracts are interchangeable and therefore liquid.

What is a forward?

A non-standardised contract for future delivery, negotiated between two parties It is more flexible but carries counterparty risk.

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3. The clearing house

What does the clearing house do?

It steps in between buyer and seller It becomes the counterparty of both.

Which risk does it remove for the two parties?

The risk that the other party fails to perform Counterparty risk passes to the clearing house.

How does the clearing house protect itself?

With security deposits and daily recalculation of gains and losses Margins and daily valuation are the two safeguards.

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4. Long position and short position

When does someone with a short position gain?

When the price falls The seller gains if they can buy back for less.

Do you need to own the underlying to sell a future?

No, what is traded is a future commitment Selling is as simple as buying.

How is a position closed before expiry?

By carrying out the opposite trade on the same contract The buyer sells, the seller buys.

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5. Hedging and speculation

What does someone hedging with futures want to achieve?

To reduce a risk they already have Hedging serves to fix a price in advance.

Why does a farmer sell wheat futures?

To fix the selling price of the harvest It protects against a fall in the price before the harvest.

What is the role of speculators?

Taking on the risk passed on by hedgers and providing liquidity They make it possible to find a counterparty.

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6. Initial margin and maintenance margin

What is the initial margin?

The security deposit posted to open the position It is a small percentage of the value of the contract.

When is a margin call triggered?

When the balance falls below the maintenance margin Losses have eroded the deposit beyond the threshold.

Can margins change?

Yes, the exchange can raise them when volatility increases The increase can come without notice.

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7. Daily valuation

What is mark to market?

The daily recalculation of positions at the closing price Every day positions are revalued.

When are gains and losses settled?

Every day, in cash Credits and debits are daily.

What is the practical consequence for someone who is losing?

They must have cash available immediately Losses have to be covered day by day.

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8. Multiplier and contract value

How much is one index point worth in the E-mini future on the S&P 500?

50 dollars The E-mini multiplier is 50 dollars per point.

With the index at 6,000 points, what value does one E-mini contract control?

300,000 dollars 6,000 points times 50 dollars.

How much is one point worth in the Micro E-mini on the S&P 500?

5 dollars It is one tenth of the larger contract.

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9. Expiries and rollover

Which contract is usually the most traded?

The one closest to expiry Liquidity is concentrated on the nearest expiry.

What is rollover?

Closing the expiring contract and opening one on the next expiry It serves to keep the position beyond expiry.

Why does rollover have a cost or a gain?

Because the two contracts have different prices The price difference between expiries feeds into the result.

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10. Physical delivery and cash settlement

What happens with physical delivery?

The seller delivers the underlying and the buyer pays for it It is typical of many commodities.

How are stock index futures closed at expiry?

With cash settlement of the difference An index cannot be delivered.

What happens to most positions?

They are closed before expiry Delivery concerns a small part of the contracts.

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11. Spot price, futures price and basis

What is the spot price?

The price for immediate delivery It is the price of the underlying for immediate delivery.

What is the basis?

The difference between the spot price and the futures price It is the gap between the two prices.

Which risk remains for hedgers?

The risk that the basis moves unexpectedly Hedging does not remove basis risk.

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12. Contango and backwardation

When is a market in contango?

When distant expiries cost more than near ones The price curve slopes upward.

What does backwardation often signal?

That the asset is scarce and those who need it immediately pay more The near expiry is worth more than the distant ones.

What effect does contango have on someone rolling a long position?

A cost at every renewal The expiring contract is sold for less and the next one bought for more.

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13. The cost of carry

What does the cost of carry include?

Financing, storage and insurance, net of any income These are the costs of holding the asset until expiry.

What is the futures price close to in normal conditions?

The spot price plus the cost of carry This is the link between the two prices.

What does arbitrage do?

It tends to bring prices back into line You buy where it costs less and sell where it costs more.

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14. Convergence at expiry

What happens to futures and spot prices as expiry approaches?

They tend to coincide This is the phenomenon of convergence.

Why is convergence important?

Because it ties the future to the real market for the underlying It is what makes the future useful for hedging.

What holds the two prices together at expiry?

The possibility of delivery Without that possibility prices could diverge.

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15. Oil in April 2020

What happened on 20 April 2020 to the WTI crude oil future expiring in May?

It closed at a negative price It closed at minus 37.63 dollars a barrel.

Why were those with long positions in difficulty?

Because storage was almost full and there was nowhere to put the oil The contract provides for physical delivery at Cushing.

What does this case show?

That a future is an obligation and physical delivery is real Near expiry the concrete conditions of the market are what count.

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