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The Nature of Futures Contracts

Posted on 11 October 2013

What is a futures contract?
A futures contract is a standardised agreement, made on a recognised exchange, to buy or sell a specified quantity of a described commodity at an agreed date in the future. The purpose of such agreements is to provide those who deal in the traded commodities (which include financial commodities such as Bank Bills and Treasury Bonds) with a facility for managing the risks associated with changing prices for those commodities (including fluctuations in interest rates and share market indices). In addition to those who deal in the markets for the purposes of risk management, there are also those who trade in the hope of profiting from changing prices in the traded commodities, ie: speculators.

Types of futures contracts
There are two main types of futures contracts. One is an agreement under which the seller agrees to deliver to the buyer, and the buyer agrees to take delivery of, the quantity of the commodity described in the contract. Such contracts will be described in this document as deliverable contracts. The other kind is an agreement under which the two parties will make a cash adjustment between them according to whether the price of a commodity or security has risen or fallen since the time the contract was made. Such contracts will be described in this document as cash settlement contracts.

Contract specifications
The terms and conditions of a futures contract are set out in the rules and regulations of the exchange on which the contract was made. Futures exchanges exist in a number of countries and regions including the United States of America, the United Kingdom, Europe, Asia as well as Australia. The material in this document is intended to refer to any futures contract traded on any exchange, but there may be differences in procedure and regulation of markets from one country to another and one exchange to another.

Futures contracts are made for periods of up to several years in the future, although the vast majority are for settlement within six months of the agreement being made. Part of the standardisation of contracts is that the time of delivery or settlement is one of a series of standardised maturity times. For example, in the All Ordinaries Share Index futures contracts traded on the Sydney Futures Exchange (SFE), contracts can be made for settlement at the end of March, June, September, or December during a period of 18 months from the time of the trade.

Deliverable contracts involve an obligation to deliver or take delivery at maturity, and it is not advisable to enter into such contracts in the last weeks before maturity unless actual delivery is contemplated. It is the policy of some brokers not to permit actual delivery unless prior arrangement with the broker is made or it is required by the clearing house. If actual delivery is intended, it is essential to first check with the broker.

Futures contracts are standardised
A result of contract standardisation is that price and volume are the only factors that are to be determined in the marketplace. Price discovery can occur by means of an open outcry system, under which brokers on the trading Full state aloud the prices at which they are prepared to buy or sell, giving other brokers with an interest in that commodity an equal chance of deciding whether to accept a bid (buying price) or offer (selling price) or by means of an electronic trading system. Futures prices represent a consensus of market opinion as to what the price of the commodity should be at the specified future time.

Since all futures contracts for a given future month in the same market are exactly alike, obligations under futures contracts are easily transferred from one party to another. A client who holds a contract to buy may cancel this obligation by taking a new contract to sell in the same month, a process known as offsetting or closing out the contract. In the same way, the holder of a contract to sell can close out by taking a new contract to buy. In each case there will be a profit or loss equal to the difference between the buying and selling prices multiplied by the standard contract amount. In practice the vast majority of contracts (some 98 per cent) are offset in this manner, the remainder being fulfilled by delivery or by mandatory cash settlement in those markets where no provision for delivery exists.

Closing out
Closing out can be achieved without reference to the original party with whom the contract is traded because of a system of novation, or substitution of one contracting party for another. The clearing house stands between the buying and selling brokers, guaranteeing contract performance to each of them (but not the individual clients, who rely on the financial integrity of their brokers). For example, in the case of the Sydney Futures Exchange Clearing House, the clearing house provides this guarantee by assuming as principal the opposite side of all contracts. Thus in practical terms the clearing house is able to substitute a new buyer as the contract party when an existing buyer sells to close out his position.

This can be represented by the following:

                                    A sells to B at $100 per unit

                                    B sells to C at $120 per unit

                                    B has quit the market and has a profit of $20 per unit

                                    At maturity, A (seller) is matched with C (buyer).

In effect, C has replaced B as the buyer of the contract from A. The contracts which B held (one to buy and one to sell) have been settled in cash; B simply receives a profit.

In such a case, any profit due to B is paid out by the clearing house in cash, even though the original seller (A) remains in the market. The clearing house ensures that it is able to pay such profits by calling for initial margins (deposits) and variation margins to cover any unrealised losses in the market. Variation margins must be paid by any client (as far as the clearing house is concerned the clearing participant) whose contract is showing a loss; i.e. if the market falls after a purchase or rises after a sale. For example if I make a futures contract to buy 100 ounces of gold in September at $400 an ounce, and the price for delivery in September falls to $380 an ounce, I will be required by my broker to pay a variation margin of $20 an ounce or $2,000. This variation margin ensures that the clearing house will have cash on hand to pay equivalent profit to the clearing participant holding an opposite position. If the market fails to recover before my contract matures, this variation margin will not be recovered; it would then become a realised loss.

Initial Margin (Deposit) and Variation Margin
As mentioned above, there are two types of margins namely initial margins which sometimes are called deposits and variation margins. In order to protect the financial security of both the broker and the clearing house until variation margins are paid, each client in the market is required to put up an initial margin in order to trade. Contract initial margins are governed by the minimum set by the clearing house or the futures exchange or both and vary from time to time according to the volatility of the market in question. This means that an initial margin may change after a position has been opened, requiring a further payment (or refund on request) at that time. They are carefully calculated to cover the maximum expected movement in the market from one day to the next. It should be noted that a broker is entitled to call (which means a demand for payment) a higher initial margin than the minimum set in order to protect its personal obligation incurred when dealing on behalf of a client. Liability for initial margin occurs at the time of the trade regardless of whether a call for payment is made or not.

Brokers are not obliged to call their clients for variation margins on a daily basis, but must call on them to pay a variation margin once the client’s net unrealised loss is more than 25% of the total initial margins in the case of SFE contracts (requirements relating to contracts traded on other markets will vary). Brokers are also under an obligation under exchange rules to collect an initial margin on each trade equal to at least the minimum initial margin set down by the clearing house or other margins determined by the exchange. Liability to pay variation margins occur as they are incurred regardless if a call for payment is made or not. Initial margins and variation margins must be paid immediately (this is generally taken to mean within twenty-four (24) hours of the call although in times of extreme price volatility this may mean as little as one (1) hour). If a client does not pay a margin, the broker is entitled to close out the client’s position and deduct the resulting realised loss from the initial margin.

The liability of a client under a futures contract is not limited to the amount of the initial margin made at the time the contract was opened. If, after paying a variation margin, the futures price continues to move against the client, further variation margins will be called. Variation margin payments can therefore exceed the amount of the initial margin. Initial margins (unless eroded by losses) are returned on settlement of the contract. Margins that become realised losses are not refundable unless there is a favourable change of direction in market prices prior to settlement or closing out of the contract.

What is a futures option?
On many futures exchanges, futures options (option contracts over futures contracts) are available in addition to futures contracts. An option on a futures contract can be defined as a contract which gives the buyer the right, but not the obligation, to buy or sell a futures contract at a pre-determined price known as the strike price, on or before a specified date in the future. In exchange for this right, the buyer pays the seller a sum of money known as the option premium.

There are two types of options. A call option is an option to buy in the futures market at a designated price (the exercise price or striking price), at any time before the option expires, irrespective of the current futures price. A put option is an option to sell in the futures market at the exercise price. Like futures contracts, options are standardised, so that having bought an option it is possible to sell it later to a third party.

Depending on the nature of the option, an option may be exercised at any time prior to expiry or only on expiry. Upon exercise, a buyer (taker) and a seller (granter) are required to take up the resulting futures positions.

There are two parties to an option contract; the buyer (or taker) and the seller (or granter). If the option is exercised, it becomes a futures contract, and the buyer of a call option then has a bought futures position at the exercise price, while the seller (granter) is required to take the opposite (sold) side of this futures contract.

If the option was a put option, the buyer, on exercise, then has a futures contract to sell at the exercise price and the seller (granter) has a futures contract to buy at this price.

Provided the buyer pays the full amount of the premium which is non-refundable at the time the option is traded, he will not be called upon to pay margins; if he pays only an initial margin (deposit), he may be called upon to pay margins up to the full value of the premium (but no more). Providing the underlying futures market has moved in his favour, the holder of an option can profit by selling it later at a higher premium, or by exercising it and closing out the resulting futures contract. The profit depends on the movement in the underlying futures market and is potentially unlimited. However, if the conditions do not suit the buyer, then the option can be left to lapse and the buyer simply foregoes the premium paid.

On the other hand, sellers (granters) of option contracts have limited profit potential (they cannot earn more than the premium for which the option is sold) and have similar potential liability to the holder of a futures contract, that is, unlimited potential for loss. Margins will be called if the market price moves against the seller.

The nature of the obligations assumed by a person who instructs a futures broker to enter into a futures contract
Clients of futures brokers (who under exchange rules must enter into a written agreement with their clients), having given instructions to their broker to enter into futures or options contracts on their behalf, must be prepared to:

(a)  Pay an initial margin on each contract equal to at least the minimum initial margin set down by the relevant exchange or clearing house for that contract. A broker is entitled to call a higher initial margin than the minimum set in order to protect its position as principal. The initial margin liability is incurred upon execution of an order.

(b)  Pay any calls made by the broker for variation margins (see above) to maintain the futures position (ie: contract or set of contracts) held by the client. The variation margin liability is incurred at the time of occurrence of any movement in the market which results in an unrealised loss for the client. Under exchange rules, brokers must call variation margins from their clients once the client’s net unrealised loss in the market is more than about 25% of the client’s total initial margins, although they may call for variation margins at any time after the margin liability is incurred. Non-payment of variation margins within the earliest reasonable time (generally deemed to be twenty-four (24) hours from the time of the call although in times of extreme price volatility this may mean as little as one (1) hour) may result in the client’s position being closed out and the resulting loss being deducted from the initial margin.

(c)  Deliver, or take delivery of and pay the contract price in full for, the commodities or securities described in the specifications of any contract held by the client which is still in force at the close of trading on the last day of trading in the relevant market and which is a deliverable contract.

(d)  Pay up any losses, which are incurred as a result of a mandatory cash adjustment made on a cash settlement contract held by the client which is still in force at the close of trading on the last day of trading in the relevant market.

(e)  Waive any interest on funds deposited with the broker, whether for initial margins or variation margins or deposited for the purpose of trading in futures and options contracts, unless the written agreement between the broker and the client stipulates that interest is to be paid on such funds. (Note that interest is not paid on variation margins under such an agreement).

(f)  Take up the opposite position in the futures market from the resulting position held by the buyer of an option, if the client has sold (ie: granted) an option and the option is exercised by the option buyer.

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BBY Investing is hiring Private Client Advisors

Posted on 8 October 2013

BBY are seeking experienced Private Client Advisors who have:

  • proven sales and business developments results
  • an existing or transferrable client base
  • appropriate qualification
  • sound knowledge of industry regulation and compliance underpinned by a strong ethical foundation

For full details, please click here to view the flyer.

If you match our ideal candidate profile, we would be very keen to hear from you.

BBY (NZ) Limited, a specialist advisor in Futures – FX – CFD – Options – Shares – Gold – Silver – Commodities

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team Graham Parlane

Chart of interest - Gold

Posted by Graham Parlane on 23 August 2013

The decade long rally in Gold has been in a wide ‘flat bottom triangle’ consolidation for nigh on a year now. My main premise has been that the Gold market is sitting ‘long’ and that there would be very little oomph from any further Fed action. As such I have been looking for a potential shake out to the downside.

My view is in jeopardy as the precious metals have put in very good performances over the last few days. Recall Gold and Silver were amongst the biggest beneficiaries of the printing programs previously.

Given developments the Gold charts are particularly interesting.

Fig 1) – 10 year Gold chart

10 year Gold chart – click here to view

Fig 2) – A closer look. US$1,660.00 looks a key level.

Closer look Gold chart – click here to view

Cheers G

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team Graham Parlane

Chart of interest - USD/JPY

Posted by Graham Parlane on 28 May 2013


The USD/JPY has been consolidating its mammoth gains of recent months tracing out a ‘bull pennant’ between 96.00/100.00 over the last 4 weeks.

USDJPY – Click here to view chart

Friday’s jump higher on the U.S. payrolls data occurred perfectly out of my model.

USDJPY Model – Click here to view chart

The reason I believe USD/JPY is set to resume its uptrend after the month of sideways is, apart from Japan’s incredible monetary policy program, is that USD/JPY moves are highly correlated to U.S interest rate yields and as in my earlier chart of interest documenting the U.S. 10 year bond those yields look likely to go higher in coming weeks. Thus I believe we have a more fundamental support for USD/JPY again now.

Market talk has it that massive stop loss buy orders have accumulated above 100.00 so any move through there may well see an acceleration of the uptrend.

Regards G

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team Graham Parlane

Chart of interest - USD Index (DXY)

Posted by Graham Parlane on 28 May 2013


How strong is the USD ? Is the strength likely to last?

These two questions obviously go to the heart of matters at the moment and if the answer can be found then we can potentially unlock great profits.

After years of being shunned it appears that the U.S. is once again a preferred destination of investment. Since the start of the century, and accelerated by the onset of the GFC, investment funds flew out of the U.S. and headed for emerging markets. Such was the magnitude of the drive to exit ‘old’ for ‘emerging’ that a new term was coined. The rise of the BRIC’s (Brazil, Russia, India and China) was on everyone’s radar ……largely at the expense of the U.S.

However the U.S. has always been an early mover and we must admire them for the significant policy responses that were implemented in the wake of the GFC (compared to say the Japanese after their stock market collapse in 1989 which even until today was never adequately dealt with). These actions appear to now be bearing fruit just at a time when the BRIC’s, particularly China are slowing a touch.

Thus the massive flow of funds from old to new now looks to be slowing or even reversing.

Looking at the DXY chart this theme is strongly borne out.

The monthly chart of the USD Index is particularly revealing. Firstly there appears to be a long term ‘rounding bottom’ formation of some 10 years in the making. And significantly we are on the cusp of 2 bullish engulfing months within the last 4. To me that speaks volumes to the amount of USD buying presently going on. If history generally repeats, then the implications of a close to the month for the USD at these levels, implies multiple months of further USD gains.

USD Index – Click here to view chart

The USD Index can be traded via the standard Futures contract or a CFD, both available on your BBY Online platforms. Or you may wish to simply spread USD risk through some of our old favourites in currency land, AUD, NZD, EUR, GBP and JPY. Indeed CHF could be added to this mix as a number of high profile analysts are calling for some serious weakness in CHF going forward, which makes Thursday evenings GDP release for Switzerland a must watch event (6.45pm NZT).

Cheers G.

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Australian Broking Firm Grabs New Zealand Broker

Posted on 13 May 2013

Press Release Friday, 10 May 2013

In a vote of confidence for New Zealand’s capital markets, BBY Limited (“BBY”) Australia’s largest non-bank owned full service stockbroker, has announced that it has expanded its presence in New Zealand by acquiring a controlling shareholding in Edge Capital Markets Limited, a privately owned broking firm specialising in the Futures and FX markets. The acquisition will allow the firm to expand its equities research and advisory services, and develop a stronger investment banking profile.

“BBY’s entrance to the New Zealand market enables us to add value to a new client base from which we expect strong growth” says Glenn Rosewall, Executive Chairman of BBY.  “New Zealand is a logical next step for BBY as the sale of state assets and the growth in KiwiSaver will see increased public interest, depth and activity on the NZX.”

The existing NZ principals and management will retain a significant shareholding in the new operation, which will be renamed BBY (NZ) Limited, and operate as a subsidiary of BBY.  The current executive management of Bryn Griffiths and Brent Weenink will be retained as Regional Head and CEO respectively, and will be joined on the Board by BBY’s Glenn Rosewall (Chairman) and Arun Maharaj.

“BBY through its extensive licensing will have the opportunity to offer one of the broadest base of products available toNew Zealandprivate investors and institutions. This includes international equities, options, bonds, futures, CFDs, margin-FX, Foreign Exchange, commodities and precious metals trading.” says Arun Maharaj, CEO of BBY “Having a New Zealand operation means we complement our Australian, UK and US teams with market information flowing around the world seamlessly.”

Bryn Griffiths was pleased with the acquisition, “We have enjoyed a close working relationship with BBY for many years, and this is a natural and positive step forward for us and our clients.  The Company is well placed to grow its advisor base, develop and deliver new services and opportunities in the New Zealand market.”

For further information, please contact:

Glenn Rosewall
Executive Chairman, BBY Limited
Tel: (02) 9226 0032

Arun Maharaj
CEO, BBY Limited
Tel: (02) 9226 0108

Henry Fung
Marketing Manager, BBY Limited
Tel: (02) 9226 0098

Bryn Griffiths
Regional Head, BBY (NZ) Limited
Tel: (04) 910-1611

Brent Weenink
CEO, BBY (NZ) Limited
Tel: (04) 910-1610


About BBY

BBY is a proudly Australian & New Zealand independent financial services group and Australia’s largest non-bank owned stockbroker. BBY has offices and staff in Sydney, Melbourne, Perth, Adelaide, Gold Coast, Auckland, Wellington, London and New York. With an extensive global reach, BBY is able to service the local and international needs of high growth companies, institutional investors, broker dealers and private investors.

Today, BBY is one of the fastest growing, securities firms in Australia and New Zealand with an average of $100 million per day turnover on the Australian Stock Exchange (17th by market share, 2nd by options market share). BBY also ranks as the 4th Best Equity Capital Markets Bank in Australia according to the 2012 East Coles Survey.

Furthermore, BBY has stayed ahead of the curve by not only educating its client, but also by sourcing the best platforms on offer around the world. BBY Online, BBY Investing and BBY Education currently offer Australia and New Zealand’s largest range of tradeable instruments.

BBY has a wealth of Australian and international institutional clients with over $2 billion worth of capital raisings completed in the last 5 years.

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team Graham Parlane

Chart of interest - EUR/JPY

Posted by Graham Parlane on 27 March 2013


After a mammoth rally from 94.00 to nearly 128 since mid-2012 the EURJPY cross is showing signs of fatigue.

Breaking down the component legs, the JPY has weakened massively (USD/JPY 78 to 97) over the same period, firstly on expectations that new PM Abe would gain power and bring with him super easy monetary policy ideas and then a secondary rally on expectations that Abe would install the like-minded Kuroda as his BOJ Governor. Since the inception of Kuroda the same sounds bites regarding easy policy have been forthcoming but the JPY has actually strengthened. Is this the biggest ever example of the old adage ‘buy the rumour, sell the fact’?

Looking at the EUR leg, the EUR simply looks awful. The Cyprus ‘precedent’ hangs heavily, manufacturing indexes remain mired in heavily negative territory and constant growth downgrades have been forthcoming. Indeed ratings agency S&P today lowered the Eurozone growth forecast to -0.5%, increasing the recessionary outlook.

Moving to the charts,  the brief rally on the Cyprus resolution Monday was quickly reversed, the price action tracing out the bearish engulfing day which augurs strongly for more losses ahead. Supporting the bearish stance the 10/20 day moving average are crossing over to a negative alignment. On the shorter timeframes my ‘model’ has done a stellar job of capping gains and is currently pushing down suggesting strong resistance lies at 122.70/123.20 and falling.

EURJPY – click here to view chart

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NZD/GBP - are we justified up here?

Posted by Graham Parlane on 13 March 2013


The NZD/GBP has been trading around multi –decadal highs of late. With the drought and the spectre of what I think will potentially be a more dovish than expected RBNZ tomorrow is the NZD really justified up here?

I’m a trend trader at heart and I don’t really like to pick tops but…

The market is chatting about the 8.1% annualised rise in NZ house prices (data released yesterday) and how upset the RBNZ will be about that. But the central bank is clearly working to the introduction of ‘macro prudential tools’ as they call it, to restrain house prices without using the ‘blunt’ instrument which is the official cash rate. You see, the RBNZ hate hitting housing with a rise in the cash rate because that usually comes with a higher currency which hurts the tradeable sector. They’re forever between the rock and the hard place so to speak.

The moderate knowledge I have about these new tools can quickly be summed up here in the NBR article

Simply put, the introduction of these tools will to some degree limit the need for rate hikes surely?

This impending change and the drought make me very wary of NZD strength at the moment. On the other side of the equation the U.K economy has its own problems for sure but the fact that GBP/USD has fallen 16 big figures in 10 weeks suggest to me the NZD/USD could easily play catch up resulting in a lower cross. Indeed, currently I think the GBP/USD is actually due a bounce from last night’s price action.

Looking at the chart of the NZD/GBP cross yesterday was the beautifully, and emotively named ‘hanging man’…… don’t need to think too hard about whether that’s a good sign or a bad sign huh? Downside follow through is beginning immediately after in today’s trade. I have high expectations for a move lower as a result

NZDGBP – click here to view chart

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team Graham Parlane

Chart of interest - AUD/EUR (the sleeper trade of 2013?)

Posted by Graham Parlane on 8 March 2013

Hi all

This is one of my dead set favourite trades.

Since the onset of the GFC the Australian dollar has appreciated against the EUR, almost doubling in value as the market sought refuge from the beleaguered EuroZone and finding haven in the high yield, proxy to China growth, AAA rated Australian dollar. What an incredible run.

AUDEUR – click here to view chart

However late last year things began to change with the Troika providing enough funds, and therefore time, for the EuroZone politicians to make the required fiscal changes i.e. labour market, pension reform etc. Meanwhile the RBA forecast an earlier peak in mining investment and resumed cutting rates.

It is my belief that the NZD and AUD currencies are vulnerable to their own success of the last few years (the cure for a high currency is a high currency – eventually it’ll hurt). I think too that Eurozone data will surprise to the topside in as much as it surely can’t get worse.

Technically the picture looks intriguing. We had the ‘head and shoulders’ break down below the neckline and then, as so often happens the retest. Now we look likely to resume the move that should head towards 0.7000

AUDEUR a closer look – click here to view chart

Cheers G.

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team Graham Parlane

Chart of Interest - Sugar

Posted by Graham Parlane on 8 March 2013


I’ve been stalking this one for a while now. Wedge formations are notoriously long lasting so patience has been required.

Interestingly I cannot find a lot of buzz on the wires (which I like!) about the latest move apart from expectations thatChina’s imports will rise in Q1

1)     Long term picture – The price of Sugar has halved over the last 2 years

Click here to view chart

2)     A closer look. The suggestion here is that Sugar broke below the long term support line but quickly reversed and then days later has bounded higher again. Could this be a very significant and long term low in place now?

Closer look – click here to view chart

I’ll be watching the news wires to see if there is a developing Sugar story over coming days and weeks.

Cheers G.

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