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Whatever type of investment you are considering--including but not limited to futures contracts--it makes sense to begin by obtaining as much information as possible about that particular investment. The more you know in advance, the less likely there will be surprises later on. Moreover, even among futures contracts, there are important differences which--because they can affect your investment results--should be taken into account in making your investment decisions.
The Contract Unit
Delivery-type futures contracts stipulate the specifications of the commodity to be delivered (such as 5,000 bushels of grain, 40,000 pounds of livestock, or 100 troy ounces of gold). Foreign currency futures provide for delivery of a specified number of marks, francs, yen, pounds or pesos. U.S. Treasury obligation futures are in terms of instruments having a stated face value (such as $100,000 or $1 million) at maturity. Futures contracts that call for cash settlement rather than delivery are based on a given index number times a specified dollar multiple. This is the case, for example, with stock index futures. Whatever the yardstick, it's important to know precisely what it is you would be buying or selling, and the quantity you would be buying or selling.
How Prices are Quoted
Futures prices are usually quoted the same way prices are quoted in the cash market (where a cash market exists). That is, in dollars, cents, and sometimes fractions of a cent, per bushel, pound or ounce; also in dollars, cents and increments of a cent for foreign currencies; and in points and percentages of a point for financial instruments. Cash settlement contract prices are quoted in terms of an index number, usually stated to two decimal points. Be certain you understand the price quotation system for the particular futures contract you are considering.
Minimum Price Changes
Exchanges establish the minimum amount that the price can fluctuate upward or downward. This is known as the "tick" For example, each tick for grain is 0.25 cents per bushel. On a 5,000 bushel futures contract, that's $12.50. On a gold futures contract, the tick is 10 cents per ounce, which on a 100 ounce contract is $10. You'll want to familiarize yourself with the minimum price fluctuation--the tick size--for whatever futures contracts you plan to trade. And, of course, you'll need to know how a price change of any given amount will affect the value of the contract.
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 and 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 10 cents a bushel and the previous day's settlement price was $3.00, there can not be trading during the current day at any price below $2.90 or above $3.10. 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 which may be involved.
Daily price limits set by the exchanges are subject to change. They can, for example, be increased once the market price has increased or decreased by the existing limit for a given number of successive days.
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
Although the average trader is unlikely to ever approach them, exchanges and the CFTC establish limits on the maximum speculative position that any one person can have at one time in any one futures contract. The purpose is to prevent one buyer or seller from being able to exert undue influence on the price in either the establishment or liquidation of positions. Position limits are stated in number of contracts or total units of the commodity.
The easiest way to obtain the types of information just discussed is to
ask your broker or other advisor to provide you with a copy of the
contract specifications for the specific futures contracts you are
thinking about trading. Or you can obtain the information from the
exchange where the contract is traded.
excerpted from Understanding Opportunities and Risks in Futures Trading
Copyright 1986 by National Futures Association
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