Page 51 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes

Notes Offsetting Position
This type of settlement is evidenced in 90% of futures settlement worldwide. Affecting an
offsetting futures transaction means entering into a reverse trade of the initial position.
The initial buyer (long) liquidates his position by selling (going short) a similar future
contract, and initial seller (short) goes for buying (long) an identical contract. In our
previous example, the long investor enters into a short Nifty Futures at delivery price of
3225. This is because the investor does not wish to take delivery (or rather cash settle) the
futures. Offsetting is a process of carrying forward the transaction by changing sides.

Self Assessment

Fill in the blanks:

14. ………… delivery is common with commodities and bonds.
15. ……….cannot be delivered physically.
16. Affecting an offsetting futures transaction means entering into a ………… trade of the
initial position.
4.6 Summary

 The futures market is a global market place, initially created as a place for farmers and
merchants to buy and sell commodities for either spot or future delivery.

 This was done to lessen the risk of both waste and scarcity.
 Rather than trade in physical commodities, futures markets buy and sell futures contracts,
which state the price per unit, type, value, quality and quantity of the commodity in
question, as well as the month the contract expires.
 The players in the futures market are hedgers and speculators.

 A hedger tries to minimize risk by buying or selling now in an effort to avoid rising or
declining prices.
 Conversely, the speculator will try to profit from the risks by buying or selling now in
anticipation of rising or declining prices.
 Futures accounts are credited or debited daily, depending on profits or losses incurred.
 The futures market is also characterized as being highly leveraged due to its margins;
although leverage works as a double-edged sword.
 It's important to understand the arithmetic of leverage when calculating profit and loss, as
well as the minimum price movements and daily price limits at which contracts can trade.

 "Going long," "going short," and "spreads" are the most common strategies used when
trading on the futures market.

4.7 Keywords

Commodity Future Contract: An agreement to buy or sell a set amount of a commodity at a
predetermined price and date.

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