Specification of Futures Contract

The derivatives exchange has to specify the exact characteristics of every futures contract. These are the underlying asset, the contract size, and where and when delivery has to be made.

In some cases (especially with commodity futures), alternatives are specified, and the trader with the short position can choose the alternative.

Commodity futures have many alternative grades in respect of their underlying asset. The derivatives exchange, therefore, specifies a certain range of acceptable

grades. The derivatives’ price is sometimes adjusted, depending on the grade delivered. With financial futures, that issue is less important.

In respect of fixed income futures like Bond futures, different bonds can be delivered, and the exchange has formulas for adjusting the price, which depends on the specific bond’s coupon and maturity.

Some financial futures, especially on share indices, are settled in cash because it is impossible to deliver the underlying.

1. Contract Size: The contract size is solely specified by the derivatives exchange without any variations of the size.

2. Place of Delivery: The place of delivery is very important because commodity futures’ underlying can involve huge transportation costs. At times, the price again depends on the delivery location.

3. Delivery Months: Several delivery months are always traded on the same underlying and the delivery month also determines the contract.

The derivatives exchange, therefore, specifies the exact time or period during the delivery month when the delivery has to be made.

The trading calendar publishes all the delivery dates per month. Different months are required because the exchange tries to meet traders’ different preferences regarding futures’ maturity.

4. Price Movement Limits: There are also other general regulations for every future listed by the derivatives exchange.

Often there are daily price movement limits, and trading is stopped for the day if these limits are exceeded.

By introducing these price limits, the derivatives exchange tries to prevent excessive speculation.

Position limits are also often introduced to limit the maximum number of contracts a speculator may hold.

This measure reduces the chances of a single speculator influencing the market through his sheer trading volume.

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