Analysis of Asset Allocation

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FUTURES : Specifications of Futures Contract
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To be 'tradable' on an exchange, the characteristics of the futures contract must be defined. The investors must know the underlying asset, the quantity to be deliver, the delivery arrangements and the delivery date.

The Underlying Asset.

The exchanged asset must be properly defined. If the underlying asset is a financial instrument, this is not a problem but if the underlying asset is a commodity, there may quite a variation in the quality of what is available on the market. When the asset is specified, it is therefore important that the exchange stipulate the characteristics that are acceptable.

The Contract Size.

The contract size is the amount of underlying asset that has to be delivered under one contract. This one must be fixed at a correct size because is the size is too small, trading will be too expensive, and if the size is too small the instruments can be illiquid or unusable to hedge small stocks.

The Delivery Arrangements.

The exchange must specify the delivery arrangements. For some instruments delivery is impossible (for example an Index). For other the place must be specified because the place where it is delivered may involve huge transportation costs.

The Delivery Date.

A futures contract is referred to by its delivery month specified by the exchange. It can be or a date or a month depending on the nature of the underlying asset.

On top of these major characteristics, some other rules are generally fixed:

  • Price quotes: the future must be quote in a way that is easy to understand. For example, crude oil quoted in dollar cents per barrel, Treasury bond and note futures in dollars and 1/32 of a dollar. From there the minimum price movement can be deducted.

  • Daily Price Movement Limit: usually to avoid speculative excesses, daily price movements limits are fixed. Once the limit up or down is reached, trading is suspended.

  • Position Limits: the maximum position an investor can have on a specific instrument.

 


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