A futures contract is a standardized agreement whereby two parties agree to exchange an asset (physical or financial), at a specified price at a future date.
The most widely used contract model in financial hedging operations is the one prepared by the International Swaps and Derivatives Association of the United States, known as ISDA.
This document is concerned with accurately defining both the more general terms and the specific assumptions that may affect operations. As well as the mechanisms to avoid the risk of default between the parties through central clearing houses, which are those that request and manage the guarantees on the asset in question, as well as the positions between the buyer and the seller.
Unlike an OTC (Over the Counter) derivatives contract where the contract is bilateral and there is no clearing house. In an OTC contract, the investor does not deposit guarantees or, if they do deposit them, they are usually much lower than those of the futures market, the most common being a netting and collateral agreement with the counterparty.
They are also known simply as 'futures'.
Characteristics of futures contracts
Every futures contract has the following standard characteristics:
- Face value of the contract
The nominal value of the contract is calculated through the following formula:
VN = Quote * Value per point
- Value per point or tick
It is the multiplier of the futures contract.
- Tick size
It is the minimum variation in the price of a futures contract.
- Guarantees required by contract
They are the guarantees required to cover market risk and be able to operate on the future.
It can be monthly or quarterly. This expiration is known as Roll Over.
Types of futures contracts
Futures contracts allow the introduction of long positions and short positions. There are the following types of futures depending on the underlying asset to which they replicate:
- Foreign exchange
- Raw Materials
- Stock indices
Formula for calculating a future
The formula for calculating a future is as follows:
Theoretical future value = [Cash Value (CV) * [1 + ((r * t) /)] - [D * (1 + (r * t ’) /)]
r = Interest rate
t = Number of days until expiration
D = Dividends
t ’= Number of days between the date of payment of the dividend and the expiration of the contract
Example of a futures contract
Suppose that we have to calculate the theoretical price of a futures contract with a 4-month maturity of an X share that trades on the market at 20 euros, with the market interest rate being 1% per year.
VT = 20 * (1 + (0.01 * 120/360) - 0 (No dividend payment) = 20.06 euros