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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.
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