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Unit 4: Introduction to Future Contracts

Self Assessment Notes

Fill in the blanks:
9. …………………………….is the price at which an underlying asset trades in the spot market.
10. …………………………...is the date on which the final settlement of the contract takes
place.
11. ……………………………is defined as the futures price minus the spot price.

4.4 Types of Future Contracts

Futures contracts are of three major categories. These are explained in the following sub-sections:

4.4.1 Stock Index Futures

These futures contract without actual delivery were introduced only in 1982 and are the most
recent major futures contract to emerge. In the United States, these contracts trade on several
market indices like Standard and Poor’s 500, a major market index, the NYSE Index and the
Value Line Index. Numerous contracts on industry indices are now trading as well.
A stock index futures contract is a contract to buy or sell the face value of the underlying stock
index where the face value is defined as being the value of index multiplied by the specified
monetary amount.

This device makes it possible to equate the value of the stock index with that of a specific basket
of shares with the following specifications:
1. The total value of shares must match the monetary value of the index.

2. The shares selected must correspond to the set of shares used to create the index.
3. The amount of each holding must be in proportion to the market capitalisation of the
companies.

!
Caution The profit or loss from a futures contract that is settled at delivery is the difference
between the value of the index at delivery and the value when originally purchased or
sold. It is important to emphasise that the delivery at settlement cannot be in the underlying
stocks but must be in cash. The futures index at expiration is set equal to the cash index on
that day.

4.4.2 Commodity Futures

The commodity futures include:
1. Agricultural futures contracts: These contracts are traded in grains, oil and meal, livestock,
forest products, textiles and foodstuff. Several different contracts and months for delivery
are available for different grades or types of commodities in question. The contract months
depend on the seasonality and trading activity.
2. Metallurgical futures contract: This category includes genuine metal and petroleum
contracts. Among the metals, contracts are traded on gold, silver, platinum and copper. Of
the petroleum products, only heating oil, crude oil and gasoline are traded.

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