Influencing factors of futures contracts

The futures market trades in standardized contracts, and the innovation of futures varieties is carried by standardized contracts, and the innovation of futures varieties must be realized through successful contract design. The process of variety innovation is the process of selecting innovative commodities (including physical commodities and financial products) and contract design. Futures contracts inherit to a large extent the relevant characteristics of their native commodities, i.e. "commodity characteristics", which are mainly derived from the natural attributes of the relevant commodities and their spot markets to explain the various factors affecting the success of futures trading of the commodities, which are mainly derived from the spot markets of the commodities; at the same time, futures contracts are also affected by various factors of the contract design itself, i.e. the contract design. At the same time, the futures contract will also be affected by the contract design itself, i.e., the "contract characteristics", the contract characteristics from the basic principles of futures trading to analyze the success of the futures contract to the factors that affect the success of the futures contract, these factors are mainly from the futures trading process of the design of the contract and the system. Commodity Characteristics and Contract Characteristics*** together give a complete description of the factors that influence the success of a futures contract. The first important task in carrying out the innovation of futures varieties is to select among many commodities that may be traded in futures. In order to identify commodities suitable for futures trading, early foreign studies focused their attention mainly on commodity attributes. The following characteristics are usually regarded as the attributes that futures commodities should have, and these attributes have been discussed in Chinese futures books for a long time, but the research on some of these characteristics can still be continued in depth, and the following discussion may help us to broaden the idea of variety innovation.

(I) suitable for storage.

One of the economic functions of the futures market is to allocate inventory in the spot market. Holders of large inventories have two choices - either to sell the inventory or to hold it for later sale as long as the commodity does not perish or diminish during the holding period. Futures markets became an integral part of the spot-selling business by providing inventory holders with a hedge against the risk of price movements. Therefore, in the early days, futures markets followed the principle that commodities were non-perishable and suitable for storage, and the commodities traded in futures were mainly grains, cotton, coffee, rubber and metals. However, with the passage of time, the concept of suitable for storage is expanding.

First, technological advances have further expanded the criteria for suitable storage. For example, advanced refrigeration technology can make perishable commodities greatly extend the shelf life, this breakthrough makes it difficult to store commodities become available for storage, traditionally unsuitable for futures trading commodities with the conditions for futures trading, such as frozen eggs, butter and orange juice futures contracts.

Secondly, the price discovery function of the futures market changed the criteria for suitability for storage.Tomek and Gray (1970) argued: "If a commodity does not need to be stocked to meet future consumption, and the cost of stocking it is zero, then today's futures price is a prediction of the future month's spot price, which is based on the information that can be obtained, information relevant to future commodity supply and demand, such as the quantity of the commodity, the ease with which relevant substitutes are available, and the expected change in supply and demand for this commodity at different price levels." Commodities that can be produced continuously and are not easily stored (e.g., live animals, fresh eggs, soybean meal) can be traded in futures just as well as seasonal, non-continuously produced, stock commodities that are easily stored (e.g., corn). As long as a commodity is readily available through production, the commodity for futures delivery does not necessarily have to be in stock at the moment.

Relative to physical commodities, financial products, the storage problem is relatively simple, such as the national debt certificates small size, light weight, very easy to keep; and although the physical storage of currency is also very easy, but due to the use of electronic remittance and other modern methods of payment and settlement, it is no longer necessary to use the cash delivery; for the stock index futures, because of the use of the cash delivery method does not need to be used in the physical stock for delivery. Therefore, for financial products, the problem of storage and custody has been solved.

(ii) Homogeneity.

Futures contracts are different from the obvious characteristics of forward contracts is that the underlying transaction must be standardized commodities. If this condition of homogeneity is not met, the exchange will not be able to settle different market participants.

In order to make the subject matter of the transaction does not have to be completed through visual observation, detailed writing, or verbal description (with higher transaction costs) and other human sensory behavior, in the contract design process of the subject matter of the transaction must be objective, standardized descriptions, in order to make the buyer and seller are aware of what quality standards of the commodities that they can buy or have to be delivered. hoffman (1932) argued that in order to make delivery grades simple and precise, they must be based on measurable physical quantities. If a commodity lacks an official or industry-universally recognized system of quality standards (and thus the same grade cannot be differentiated), then it is destined to fail the requirements of futures trading. Tea and tobacco are commodities that fall into the category of commodities that require more personal evaluation and where it is difficult to identify grades in a standardized way that prevents futures trading. It should be noted that this characteristic is more often found in agricultural varieties.

(C) price volatility.

Price volatility plays an important role in attracting the two basic categories of participants, the preservationists and the speculators, to the futures market.Telser (1981) considers price movement as one of the important commodity characteristics that determine the suitability of a commodity for futures trading. The results of his research using cost-benefit theory indicate that changes in price volatility determine the emergence (disappearance) or growth (decline) of futures trading in a commodity. He argued that if the price volatility of a commodity declines, the demand for preservation decreases, the volume of futures trading declines, market liquidity decreases, transaction costs such as commissions and margins for investors increase, and higher transaction costs exacerbate the decrease in demand for trading, which further affects the volume of trading. Rising price volatility moves this process in the opposite direction. Higher demand causes the volume of contracts to rise, thereby increasing liquidity and lowering costs, which in turn increases the demand for trading. For speculators, the opportunity to earn spreads only exists if there is price volatility, so a rise in price volatility increases profit opportunities and the willingness of speculators to participate. The generation of financial futures lies in the implementation of floating exchange rate system line and interest rate marketization, exchange rate and interest rate price volatility increased. 20 century 80's, the United States of America, silver prices to 4% per year, while the change in the price of gold is only 1% or less, so that the silver futures trading volume exceeded the gold (gold is the most active precious metals market).

(iv) Sufficient spot size.

Futures commodities should have sufficient spot supply and demand for three reasons: first, sufficient supply of a commodity helps avoid price fixing. If the supply of a commodity is limited, it will be very easy for participants with large amounts of financial capital to control the price. Second, a large number of market participants helps to provide a large number of potential hedgers for futures trading. Third, an adequate spot market helps provide continuous and orderly supply and demand forces, which can facilitate delivery and the realization of cash arbitrage. Some scholars believe that the size of the spot circulation of commodities suitable for futures trading should be more than 5 billion dollars.

(v) Unrestricted supply.

Unrestricted supply of commodities has two meanings: one is the market without government control or monopoly; the second is lower delivery costs. Specifically:

1 Prices formed by perfect competition. If the market supply of a commodity is completely controlled by the government, a small number of monopolies, the futures market for this commodity can not be prosperous, there is spot control of the monopoly can determine the spot price (or at least powerfully influencing the price), and thus be able to manipulate the futures price. 1979 to 1980, there was an attempt to manipulate the U.S. silver futures price, although the manipulation ultimately unsuccessful, but make the silver futures trading on the New York Mercantile Exchange (NYMEX) and the Chicago Board of Trade (CBOT) to drop by 74% and 83%, respectively.

Government intervention in the market can also affect the level of participation in the futures market. Such as the government's large national reserves will make the relevant commodity futures trading to reduce or even disappear. For example, the U.S. cotton futures trading only became active after the government deregulated it.

2 Lower delivery costs. The existence of delivery costs will reduce the possibility of cash arbitrage. If the delivery cost is high, even if the period, there is a large difference in spot prices will not produce arbitrage incentives, so that the futures price and spot prices will not be able to realize the return. Higher delivery costs are usually associated with the following factors: (1) additional transportation costs incurred in transporting the commodity to the delivery location, where it is very inconvenient to have the commodity available for delivery, which may be mainly due to the unreasonable setting of the delivery location; (2) keeping the physical commodity in a deliverable state for a long period of time, etc., which may be mainly due to the seller's enterprise's management system has a problem, or manipulation of at least the intention to influence prices, or may also be due to the fact that the physical commodity is not in a deliverable state. This may be mainly due to problems in the management system of the seller's enterprise, or an intention to manipulate or at least influence the price, or it may be due to the high cost of converting the physical commodity from spot to a deliverable state for futures. These "abnormal" factors lead to high delivery costs, which even in the United States have led to a series of problems in the trading of wheat, corn, cotton and especially potato futures.

In order to solve the circulation problems encountered in the physical delivery process and to reduce delivery costs, the cash delivery system was introduced into futures trading. Cash delivery is a delivery method that does not require the use of physical goods. This method enables futures trading of many commodities that are traditionally unsuitable or difficult to realize physical delivery, such as feeder cattle futures, potato futures and stock index futures.

(vi) OTC trading.

Forward contracts do not have an exchange as a guarantor of performance and face the risk of default by the counterparty, and forward contracts are only a bilateral agreement, in the settlement date with the same more difficult, while the futures market market market participants can be hedged at any time before the delivery date to close the position. Nevertheless, OTC trading is still a substitute for futures trading. Futures trading is to extend the time of performance of the contract, so as to realize the purpose of avoiding price risk. For hedgers, however, the most efficient approach is simply to extend the delivery period, not necessarily to standardize the contract. And forward contracts can make trading conditions such as settlement date, delivery of specific commodities, quantity and price more in line with the requirements of the two sides of the transaction and other advantages, but also to a certain extent to make up for the performance risk and can not be hedged and other defects. But so far, still can't get over-the-counter trading and futures trading mutually exclusive conclusion. For example, most of the global foreign exchange transactions are concentrated in over-the-counter transactions, but the U.S. GNMA deferred delivery market and the GNMA futures market has been successful at the same time.

Above we summarize the commodity characteristics of futures contracts, but in the practice of futures trading, there are many commodities although the above conditions futures contracts have failed, while some commodities even if not fully meet the above conditions but futures trading is still successful. For example, coffee beans are graded subjectively, and there is a forward trading market for GNMA. Therefore, commodity characteristics alone cannot explain the full extent of the success or failure of a futures contract. Based on the study of commodity characteristics of futures contracts, the design of futures contracts is studied. The design of futures contract terms is a key factor that influences the trading interest of market participants. According to the trading interest or trading purpose can be divided into two basic types of futures market participants, the preservation of value and speculators, the following to analyze the impact of these two types of participants in futures trading contract characteristics.

(i) Attraction to value preservers.

Keynes argued that "if a futures contract takes into account only the interests of speculators, such a contract has no hope of success. For a market to function, there must be a real and fundamental incentive to hedge." The theory that futures contracts should be designed in such a way as to attract hedgers was developed by Working (1953), who argued that the volume of trading in futures markets is determined by the amount of hedging that takes place. So how can contracts be designed to attract hedgers? Many futures contracts were originally listed for commercial purposes, and Working (1970) suggested that "the terms of a futures contract should be consistent with the way spot trading works." This is because spot firms engage in futures trading to hedge price risk, and effective hedging needs to rely on a high degree of correlation between spot and futures prices, which necessitates that the underlying futures transaction be as close as possible to the spot commodity. And arbitrageurs may simultaneously hold futures positions and spot in kind, when the period, the spot price spread exists, they have the possibility of physical delivery, only the underlying futures transactions and spot commodities are basically in line with in order to ensure that they successfully realize the physical delivery. Therefore, the futures contract to attract the preservation of value, both the underlying futures contract as far as possible with the spot commodity, while the futures contract delivery rules should also be as far as possible in line with the circulation of spot commodities habit.

The loss of hedgers is an important reason for the failure of futures contracts. Wheat futures trading in the United States is a typical example. The Kansas City Commodity Exchange (KCBT) used to be the leading hard winter wheat futures market in the U.S. In 1940, the KCBT modified the contract to allow soft red wheat to be delivered instead, and at that time, because of the price relationship only hard winter wheat was able to enter delivery. By 1953, however, the price relationship had changed, and soft red wheat became the cheapest variety for delivery. Since the futures price of the contract no longer reflected the trend of hard winter wheat prices, hard winter wheat hedgers began to move from the KCBT to the hard spring wheat futures market on the Minneapolis Exchange (MGE) and the soft red wheat futures market on the CBOT. Since the CBOT soft red wheat futures market is very liquid and has lower transaction costs than the KCBT, and since hard winter wheat hedgers must be forced to engage in alternative hedging, on the premise of being able to achieve the purpose of reducing price risk, their trades will inevitably flow to the market with the lowest transaction costs. Thus, the second half of 1953 KCBT wheat futures contracts short volume and trading volume fell sharply, the reason is the loss of hedgers. When the Chicago Mercantile Exchange (CME) in September 1961 when the first frozen pork belly contract, although the business environment is very ideal, but because of the contract terms and conditions of the spot trade differences, such as storage time, storage methods and grade restrictions, trading has not been active. Until three years later, that is, in 1964, the exchange of these terms were modified, the contract of the volume of short sales and trading volume began to increase significantly, the reason for this lies in the modification of the contract to make the futures and spot market closer to improve the effect of value preservation. Therefore, the design of futures contracts and spot operations to match, which is very important to successfully attract the preservation of value.

(ii) Attraction of speculators.

Gray (1961, 1966, 1967) found that short hedging position and long hedging position in the number of difficult to achieve balance, the imbalance needs to be filled by speculative positions, otherwise it will produce a large price deviation; a certain amount of hedging positions need more speculative positions with it. Moderate speculation is conducive to improving the efficiency of hedging. One of the criteria for judging the efficiency of hedging is the cost of hedging. In a small turnover, trading is not alive in the market, hedging transactions are difficult to find the right price level of the transaction, but also difficult to close the position at the right time to end the hedge, which undoubtedly increases the cost of hedging and risk, which leads to a reduction in hedging, and ultimately the futures market disappears. Therefore, hedgers prefer high liquidity market, a futures market, the higher the liquidity, hedgers in and out of the market will be easier. According to Wolkin, "Although a large number of speculative trades in futures markets appear to rely on hedging transactions, for varieties traded on multiple exchanges at the same time, hedgers prefer to utilize the exchange with the highest volume of speculative transactions."

1 Cross-market arbitrage enters speculation for less liquid, similar contracts. U.S. economists once analyzed the role of speculators in the wheat futures markets of CBOT, KCBT and MGE. Initially, most hedgers preferred the KCBT and MGE wheat futures contracts because of delivery locations and delivery grades. However, CBOT is the largest wheat futures market in the U.S., with the largest number of speculators and diverse wheat delivery types. When unbalanced covered orders (when short and long positions are unequal) hit KCBT and MGE, their prices begin to diverge from CBOT wheat prices. The rising cost of hedging at KCBT and MGE eventually causes hedgers to move to CBOT, as the rising transaction costs outweigh the increased hedging effectiveness. On the other hand, however, professional investors also engage in cross-market arbitrage trading of CBOT, KCBT, and MGE wheat futures contracts, which Gray views as "shifting speculation to markets that lack speculative trading in order to support those markets through periods of speculative shortages". He attributes the existence of KCBT and MGE wheat futures to the large number of speculators at the CBOT. However, in the long run, the less liquid futures contracts of the same type will not be able to attract hedgers due to the lack of sufficient speculative behavior, and a large number of arbitrage trades will tend to narrow the spreads between the markets, which will ultimately lead to the inevitable demise of the subsidiary contracts.

2Protection contract to similar speculative contracts borrow speculative behavior. CBOT's GNMA futures contract (hereinafter referred to as the GNMA-CDR contract) stipulates that the GNMA depository receipt (collateralized depository receipt, CDR) according to a fixed formula after the price conversion for the delivery of GNMA futures contracts. For GNMA hedgers, CDR prices and GNMA (CD) futures prices are highly correlated with spot prices, enabling them to achieve the purpose of reducing basis risk. As a result, in 1978, the Amex Commodity Exchange (ACE) and the CBOT simultaneously introduced the GNMA-CD contract, which attracted the participation of hedgers, while the GNMA-CDR contract attracted most of the speculative capital. At the CBOT, the GNMA-CD is traded in the GNMA-CDR pool, as the GNMA-CD contract is "borrowed" from the GNMA-CDR market. speculative behavior. However, ACE only had the GNMA-CD contract as its primary product, which ceased trading in 1980.

3 Reducing contract size attracts speculation. In the futures market, the number of hedgers is small, the transaction amount is large, and speculators in addition to large institutional investors, there are also a large number of small and medium-sized speculators, these small and medium-sized speculators are also an important group of people to provide market liquidity. The size of the futures contract specification needs to be considered not only with reference to the spot business habits of the product concerned, but also with reference to the attractiveness to small and medium-sized speculators. If the contract specification is too small, it may bring inconvenience to the spot enterprises, but the contract size is too large, small and medium-sized speculators will be unable to participate due to the lack of funds, which in turn affects the active contract. U.S. silver futures trading in 1969 before the New York Mercantile Exchange, when trading is very active. Its contract specifications for 10,000 ounces / sheet. 1969 November, CBOT introduced a slightly modified silver futures contract - contract specifications for 5,000 ounces / sheet, a huge success, within two years to attract more than 30% of the silver futures trading volume. The New York Mercantile Exchange realized that the contract specifications of the reduced size of the promotion of the scale of trading, so they also in 1974, the silver contract specifications to 5000 ounces in order to stop the further loss of market share in the CBOT in 1981, the contract specifications will be further reduced to 1,000 ounces.

(iii) Preventing manipulation.

Contract design in the focus on attracting speculators and preservation of value at the same time, if there is a potential danger of manipulation, but also directly affect the willingness of investors, especially preservation of participation. Therefore, another goal of futures variety innovation is to design a futures contract that is difficult to be manipulated.

The time limit of the futures contract requires that when the contract expires, the balance of physical commodities and funds must be completed. However, since the actual amount of physical commodities available for delivery in the spot market is usually limited, it is possible to have an imbalance between physical commodities and funds, which can lead to delivery risk. In the general month of contract trading, buyers and sellers in the trading environment is basically similar, but as the contract expiration date (delivery date) is approaching, such as one party in the transaction showed a clear financial advantage or physical possession of the advantage (natural causes or deliberate manipulation) and the other party out of the contract, will be due to the regular risk of affecting the investor's normal trading, this type of contract usually need to be modified.

In the contract design, to prevent price manipulation is an important way to increase the grade of commodities can participate in delivery or delivery location, through the delivery of goods similar to the delivery of standard goods set a certain quality of the water, or delivery of the delivery of the benchmark outside of the delivery location to set a certain region of the water to achieve delivery, so as to increase the amount of physical delivery available. However, it should be noted that this method will also encounter some relatively difficult problems:

First of all, the effectiveness of value preservation requires that the period, the spot price must have a strong correlation. With a single deliverable grade of the contract for this grade of commodities is the most attractive, because the delivery grade is clear, the futures price reference pricing of the spot price is correspondingly clear, this period of the strongest correlation between the spot price, in the contract maturity date can be better to achieve the return. However, when there are more grades or types of substitutes, the seller will inevitably prefer to deliver the cheapest grade, and then the buyer in the delivery of what kind of commodity will be able to get increased uncertainty. Similarly, as more locations are available for delivery, the uncertainty about what the buyer will get at the time of delivery will also increase. The more classes of substitutes and the more delivery locations available, the greater the uncertainty created and the greater the likelihood that the overall effect of preservation will be affected.

Second, the design of the premium and discount is very important. Increase the quality of the discount or narrow the quality of the ascending water helps to increase the probability of delivery of delivery of standard products, in order to make the period, the spot price to maintain a better correlation, but this will affect the expansion of the amount of available for physical delivery. If the regional premium is too small or the discount is too large, it will lead to the delivery point outside the benchmark delivery place of the actual delivery is very little, and vice versa will make the benchmark delivery place of the actual delivery of the volume of reduction, both of which both increase the management cost, but did not play the role of expanding the delivery volume. Therefore, it is necessary to find a standard that can balance the two objectives of "maintaining the correlation between futures and spot prices" and "expanding the amount of physical delivery available". Because of this, the rationality of the design of the premium and discount is more demanding. The quality of the premium mainly depends on the physical commodity grade between the intrinsic quality, practical value of the difference, to determine a little easier. And regional discount is mainly related to transportation costs, inter-regional spot prices, if the cost of transportation and regional price differentials change frequently, the regional discount needs to be constantly adjusted, which will inevitably make the transaction costs in an unstable state. Therefore, to determine a reasonable and stable regional discount, the need to have a more standardized, mature, unified spot market.