More about Futures Trading
Posted: December 31st, 2020, 9:51 am
Hi everyone,
Don't get be wrong I don't want to get involved but I'm just eager to learn more on the subject (Dear Mod. if this is in the wrong board pls feel free to move). Basically I've just read This book about Fischer Black and I'm now reading this one about the fall of LTCM called When Genius Failed. They have kind of aroused a curiosity in how options and futures work.
To enquire further I did a bit of reading an existing generic financial markets book and some googling about forwards contracts e.g. with producers/farmer and consumers/miller where they, for example, strike up a contract where the farmer agrees to sell (short) a ton of wheat for £60 and the miller agrees to buy (long) this amount at that price in 3 months.
To provide security to either party, we have each of them, maintaining a margin of £6 (10% of initial spot price), and topping up the account accordingly. However if at the end of the contract wheat is now at spot price £80, the miller, who turned out to be a speculator, can settle with the farmer for £60 (initial margin + £54), and immediately sell the wheat on the market at £80, and hence make a profit of £20 on the initial margin of £6,
which results in a profit margin of 333%, i.e. 200/6. It's clear that the forward with it's lower initial margin gives the possibility of levering up the final profit.
However, how exactly does this extend onto the modern day futures market regarding leverage increasing profit margin? For example when one buys a future on a MSFT stock, is the contract on the price of the stock at some time in the future?
e.g. now MSFT is at $221, would one have a MSFT 3 month contract (long) with a predicted SP at that date of $230?
Does the speculator by buying the future today, for example, just pay the price of the contract (i.e. not the full $230 predicted value)? And is the price of the contract in some way equivalent to the earlier example of wheat, i.e. is the price of the contract just the value of the initial margin plus a fee?
So assuming that there is no fee, and the speculator purchases the future MSFT contract, and in 4 weeks the price hits $240. Then am I right that if the speculator settles the contract now he is
$230 long
$240 short
meaning $10 profit and if the cost of the contract (i.e. the initial margin) was $5, then the speculator's profit margin is 200%?
thanks Matt
Don't get be wrong I don't want to get involved but I'm just eager to learn more on the subject (Dear Mod. if this is in the wrong board pls feel free to move). Basically I've just read This book about Fischer Black and I'm now reading this one about the fall of LTCM called When Genius Failed. They have kind of aroused a curiosity in how options and futures work.
To enquire further I did a bit of reading an existing generic financial markets book and some googling about forwards contracts e.g. with producers/farmer and consumers/miller where they, for example, strike up a contract where the farmer agrees to sell (short) a ton of wheat for £60 and the miller agrees to buy (long) this amount at that price in 3 months.
To provide security to either party, we have each of them, maintaining a margin of £6 (10% of initial spot price), and topping up the account accordingly. However if at the end of the contract wheat is now at spot price £80, the miller, who turned out to be a speculator, can settle with the farmer for £60 (initial margin + £54), and immediately sell the wheat on the market at £80, and hence make a profit of £20 on the initial margin of £6,
which results in a profit margin of 333%, i.e. 200/6. It's clear that the forward with it's lower initial margin gives the possibility of levering up the final profit.
However, how exactly does this extend onto the modern day futures market regarding leverage increasing profit margin? For example when one buys a future on a MSFT stock, is the contract on the price of the stock at some time in the future?
e.g. now MSFT is at $221, would one have a MSFT 3 month contract (long) with a predicted SP at that date of $230?
Does the speculator by buying the future today, for example, just pay the price of the contract (i.e. not the full $230 predicted value)? And is the price of the contract in some way equivalent to the earlier example of wheat, i.e. is the price of the contract just the value of the initial margin plus a fee?
So assuming that there is no fee, and the speculator purchases the future MSFT contract, and in 4 weeks the price hits $240. Then am I right that if the speculator settles the contract now he is
$230 long
$240 short
meaning $10 profit and if the cost of the contract (i.e. the initial margin) was $5, then the speculator's profit margin is 200%?
thanks Matt