Chapter 2: Mechanics of Futures Markets Flashcards
(23 cards)
Define: Contract size
exactly how much of the asset will be delivered under 1 contract
Define: limit move
a move in either direction equal to the daily price limit
Define: limit up
If in a day the price moves up from the previous day’s close by an amount equal to the daily price limit, the contract is said to be limit up
Define: limit down
If in a day the price moves down from the previous day’s close by an amount equal to the daily price limit, the contract is said to be limit down
What are “position limits” and their purpose?
Position limits are the max number of contracts that a speculator may hold. Its purpose is to prevent speculators from exercising undue influence on the market.
Why does the futures price converge to the spot price?
During the delivery period, if the future price is different from the spot price, traders exploit this arbitrage opportunity. As a result, the futures price will converge to the spot price
What is daily settlement or marking to market?
at the end of each trading day, the margin account is adjusted to reflect the investor’s gain or loss.
Define: day trade
The trader announces to the broker an intent to close out the position in the same day.
Define: spread transaction
The trader simultaneously buys a contract on an asset for one maturity month and sells (i.e. takes a short position in) a contract on the same asset for another maturity month
What is the purpose of the margin system?
Ensure that funds are available to pay traders when they make a profit.
What is the settlement price used for?
The settlement price is used for calculating daily gains and losses and margin requirement.
What is the difference between trading volume and open interest?
Trading volume is the number of contracts traded in a day. Open interest is the number of contracts outstanding (i.e. the number of long positions or, equivalently, the number of short positions).
List and define the patterns of futures.
1) Normal market (sometimes referred to as contango): when settlement futures prices are an increasing function of the maturity of the contract.
2) Inverted market (sometimes referred to as backwardation): when settlement futures prices decline with maturity.
3) partly normal and partly inverted
Define: market order
A request to trade immediately at the best price available in the market
Define: limit order
The order can be executed only at this price or at one more favorable to the investor.
Define: Stop order/stop-loss order
The order is executed at the best available price once a bid or offer is made at that particular price or a less favorable price.
It is designed to place a limit on the loss that can occur in the event of unfavorable price movement
Define: stop-limit order
✓It is a combination of a “stop order” and a “limit order”.
✓Two prices must be specified in a stop-limit order: the stop price and the limit price
✓the order becomes a “limit order” as soon as a bid or offer is made at a price equal to or less favorable than the stop price
✓if the stop price=limit price, the order is sometimes called a “stop-and-limit order”
Define: market-if-touched (MIT) order
Aka board order
It is easier at the best available price after a trade occurs at a specified price or at a price more favorable than the specified price.
✓in effect, an MIT becomes a “market order” once the specified price has been hit
✓MIT is designed to endure that profits are taken if sufficiently favorable price movements occur
Define: discretionary order (or market-not-held order)
It is traded as a market order except that execution may be delayed at the broker’s discretion in an attempt to get a better price
Define: time-of-day order
It specifies a particular period of time during the day when the order can be executed.
Define: open order (or good-till-canceled order)
It is in effect until executed or until the end of trading in the particular contract
Define: fill-or-kill order
It must be executed immediately on receipt or not at all
Define: order
Unless otherwise stated, an order is a day order and expires at the end of the trading day.
