Introduction to Futures (4/5):
Futures Expiration and Financial Essentials
Understanding Futures Expiration & Contract Roll
Futures contracts, by design, have a finite lifespan, terminating on their expiration date, which typically falls on the third Friday of the expiration month, although variations exist across contracts. This finite nature necessitates strategic decision-making as expiration approaches, with traders opting to offset positions, rollover to a future contract, or proceed to settlement. For instance, in the context of WTI Crude Oil futures, a trader holding a short position might buy equivalent contracts for closure, or opt for a rollover to maintain market exposure without physical delivery.
Mark-to-Market
Mark-to-market (MTM) is a daily reckoning in futures markets, aligning contract values with current market prices. This mechanism ensures transparency and fairness, setting a uniform settlement price across holders. For example, Corn futures settle based on the last minute of trading, ensuring that all participants mark their positions to this price. This process, integral to futures trading, underscores the daily financial exchange between winners and losers, maintaining market integrity and participant equality.
Margin: Know What's Needed
Margin in futures trading, unlike securities margin, is a performance bond ensuring contract fulfillment, not a partial payment towards ownership. With initial and maintenance margins set by exchanges, traders must navigate fluctuating requirements, reflective of market volatility. Failure to meet margin calls can result in position liquidation, underscoring the importance of understanding margin dynamics. This knowledge is crucial, for instance, when trading S&P 500 futures, where margin levels dictate trading capacity and risk exposure.
Calculating Futures Contract Profit or Loss
Profit and loss in futures trading are directly tied to contract specifics, such as size and tick value. For example, a WTI Crude Oil futures contract, representing 1,000 barrels, prices movements in $0.01 ticks. A trader’s position value thus fluctuates with the market, with profits and losses crystallizing upon contract closure or offset. This calculation—multiplying the movement in ticks by the tick value and contract quantity—forms the basis of financial management in futures trading, essential for both speculative gains and hedging losses.