Futures Basics

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Postby PebbleTrader » Tue Mar 19, 2013 5:42 pm

The Contract and Trading Month

All futures have assigned a unique one- or
two-letter code that that identifies the contract
type. This abbreviation, or ticker symbol, is
used by the CBOT electronic clearing platform
and others to process all transactions. For
instance, the symbol for the Dow Future is
DJ, while the symbol for the mini-sized Dow
future is YM. This symbol is important when
you trade electronically because if you enter
the wrong symbol you could trade the
wrong contract.

In addition to the contract code, you also
need to know the month and year code.
For instance, the month code for March
is H. So if you were trading the March Dow
future in 2005 the code would be DJH5.
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Postby PebbleTrader » Tue Mar 19, 2013 5:42 pm

Contract Pricing in Ticks

It is obviously important to understand a
contract's value. This is how you determine
profit and loss, as well as entry and exit
pricing. Each futures contract has a minimum
price increment called a tick size. The term
tick size, or simply tick, dates back to the old
ticker tape machines, which were the original
means of conveying price information from
the trading floor. Traders use the word tick
to express the contract's price movement or
the amount of their profits or losses.
Another term you will have to understand
is the multiplier, which determines the value
of each tick. You can determine the value
of a day's price movement by multiplying
the movement in ticks by the multiplier.
For example, suppose the multiplier on the
mini-sized Dow future is $5. If the Dow future
moved up 10 ticks in one day, one long
contract would have gained $50 in value
(10 index ticks x $5 multiplier = $50).
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Postby PebbleTrader » Tue Mar 19, 2013 5:42 pm

Month Codes:

January F
February G
March H
April J
May K
June M
July N
August Q
September U
October V
November X
December Z
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Postby PebbleTrader » Tue Mar 19, 2013 5:43 pm

Volume and Open Interest

Next to price, volume is the most frequently
cited statistic in reference to a futures
contract's trading activity. Each unit of volume
represents a contract traded. When a trader
buys a contract and another trader sells that
same contract, that transaction is recorded
as one contract being traded. Therefore,
the volume is the total number of long or
short positions.

Open interest, on the other hand, refers to the
number of futures positions that have not been
closed out either through offset or delivery. In
other words, the futures contracts that remain
open, or unliquidated, at the close of each
trading session.

To illustrate, assume that a trader buys 15
contracts and then sells 10 of them back to
the market before the end of the trading day.
His trades add 25 contracts to the day's total
volume. Since 5 of the contracts were not
offset, open interest would increase by 5
contracts as a result of his activity.

Volume and open interest are reported daily
and are used by traders to determine the
participation in a market and the validity of
price movement. For instance, if a market
moves higher on low volume some traders
may not consider this an important price
movement. However, the same price
movement on high volume would indicate
that an important trend may be emerging.
Combining volume and open interest also
yields an interesting perspective on the
market. If a contract experiences relatively
low volume levels but high open interest,
it is generally assumed that commercial
participation is high. This is because
commercial hedgers tend to use the markets
for longer-term hedging purposes, putting
their trades in and keeping them until they're
no longer needed to manage a given price
risk. Conversely, high volume with low open
interest may indicate more speculative market
activity. This is because the majority of
speculators prefer to get in and out of the
market on a daily basis.
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Postby PebbleTrader » Tue Mar 19, 2013 6:42 pm

Daily Price Limits

Exchanges establish daily price limits for trading in futures contracts. The
limits are stated in terms of the previous day's closing price plus or minus
so many cents or dollars per trading unit. Once a futures price has
increased by its daily limit, there can be no trading at any higher price until
the next day of trading. Conversely, once a futures price has declined by
its daily limit, there can be no trading at any lower price until the next day
of trading. Thus, if the daily limit for a particular grain is currently 20 cents
bushel and the previous day's settlement was $3, there can not be trading
during the current day at any price below $2.80 or above $3.20. The price
is allowed to increase or decrease by the limit amount each day.

For some contracts, daily price limits are eliminated during the month in
which the contract expires. Because prices can become particularly volatile
during the expiration month (also called the "delivery" or "spot" month),
persons lacking experience in futures trading may wish to liquidate their
positions prior to that time. Or, at the very least, trade cautiously and with
an understanding of the risks that may be involved.

Daily price limits set by the exchanges are subject to change. They can be
either increased or decreased. Because of daily price limits, there may be
occasions when it is not possible to liquidate an existing futures position at
will. In this event, possible alternative strategies should be discussed with a
broker.
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Postby PebbleTrader » Tue Mar 19, 2013 7:11 pm

Marked-To-Market

Gains and losses on futures contracts are not only calculated on a daily
basis, they are also credited or debited to each market participant's
brokerage account on a daily basis. Thus, if a speculator were to have a
$500 profit as the result of a day's price changes, that amount would
immediately be credited to his or her account and, unless required for
other purposes, could be withdrawn. On the other hand, if the day's price
changes resulted in a $500 loss, the account would be debited for that
amount.

The process just described is known as daily cash settlement and it's an
important feature of futures trading. As will be seen when margin
requirements are discussed later, it is also the reason a customer who
incurs a loss on a futures position may be called on to immediately deposit
additional funds.
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Postby PebbleTrader » Tue Mar 19, 2013 7:19 pm

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Postby PebbleTrader » Tue Mar 19, 2013 7:20 pm

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Postby PebbleTrader » Tue Mar 19, 2013 7:28 pm

Futures are probably more similar to spot forex than stocks with the exception of the daily price limits, marked-to-market and maturity date.
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Postby PebbleTrader » Tue Mar 19, 2013 8:51 pm

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