1. Underlying asset: The futures contract must specify the asset that the contract represents. It can be a financial asset like a currency (e.g., Japanese yen) or a physical commodity like wheat. When the underlying asset is a commodity, the exchange needs to define the specific quality or grade of the commodity that will be acceptable for delivery.
Example: A futures contract on gold would represent 100 troy ounces of 24-carat gold.
2. Contract size: This feature determines the quantity of the underlying asset that must be delivered or settled when the contract expires. The contract size varies depending on the asset being traded.
Example: A futures contract for wheat with a contract size of 5,000 bushels means that the seller must deliver 5,000 bushels of wheat, and the buyer must accept and pay for 5,000 bushels of wheat when the contract matures.
3. Delivery location: The futures exchange specifies the designated location where the physical delivery of the underlying asset will take place upon contract expiration. This location is crucial for commodities and can impact the logistics and costs associated with the delivery process.
Example: A futures contract for crude oil might specify delivery at the Cushing, Oklahoma delivery point.
4. Delivery time: Futures contracts are denoted by the month in which the delivery is scheduled to occur. This is indicated in the contract's name or symbol.
Example: A December corn futures contract would mean that delivery is expected to occur in December.
5. Price quotes and tick size: The futures exchange determines how the contract's price will be quoted and the minimum price fluctuation, known as the tick size. The tick size defines the minimum price movement for the contract.
Example: If the tick size for a crude oil futures contract is $0.01 per barrel, and the contract represents 1,000 barrels, then each tick represents a $10 change in contract value (1,000 barrels x $0.01 per barrel).
6. Price limits: To prevent extreme price volatility, the exchange sets maximum price movements (daily price limits) that a contract can experience during a trading day. These limits are specified in terms of price changes from the previous day's closing price.
Example: If the daily price limit for a soybean futures contract is $0.50 per bushel, and the contract represents 5,000 bushels, then the maximum potential price change in a single day would be $2,500 (5,000 bushels x $0.50 per bushel).
7. Position limits: To control excessive speculation and market manipulation, the exchange imposes position limits, which specify the maximum number of contracts that a single speculator or entity can hold for a particular futures contract.
Example: If the position limit for a natural gas futures contract is 1,000 contracts, a speculator cannot hold more than 1,000 contracts at any given time.
These features ensure standardization and transparency in futures trading, allowing market participants to understand and evaluate the terms of the contract before engaging in trading activities.
Sure, here are some multiple-choice questions related to the key features of futures contracts along with their possible answers:
1. What does the "tick size" represent in a futures contract?
A) The minimum quantity of the underlying asset required for delivery.
B) The maximum price movement allowed during a trading day.
C) The minimum price fluctuation for the contract.
D) The designated location for physical delivery.
Answer: C) The minimum price fluctuation for the contract.
2. A futures contract on silver specifies a contract size of 5,000 troy ounces. If the price of silver increases by $0.20 per ounce, what is the potential profit or loss for a long position in the contract?
A) $500 profit
B) $2,500 profit
C) $500 loss
D) $2,500 loss
Answer: B) $2,500 profit
Explanation: Each troy ounce represents a $0.20 price movement, and the contract size is 5,000 ounces. So, the potential profit for a long position is 5,000 ounces x $0.20/ounce = $1,000. Conversely, for a short position, it would be a $1,000 loss.
3. What is the purpose of setting "position limits" in futures trading?
A) To specify the quantity of the underlying asset required for delivery.
B) To control excessive speculation and market manipulation.
C) To determine the minimum price fluctuation for the contract.
D) To set the maximum price movement allowed during a trading day.
Answer: B) To control excessive speculation and market manipulation.
4. If the daily price limit for a crude oil futures contract is $5 per barrel, and the contract represents 1,000 barrels, what would happen if the contract's price increases by $5 and reaches the daily price limit?
A) The contract will be "limit up," and trading will halt for the day.
B) The contract will be "limit down," and trading will halt for the day.
C) The contract will continue to trade without any restrictions.
D) The contract will be "at the money," and trading will continue as normal.
Answer: A) The contract will be "limit up," and trading will halt for the day.
5. Which of the following is NOT an essential feature specified in a futures contract?
A) Underlying asset
B) Contract size
C) Delivery location
D) Market price at settlement
Answer: D) Market price at settlement
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