Understanding Futures
The term "Futures" originates from the English word itself, indicating "future goods." Buying and selling futures essentially means trading a contract for goods in the future.
The concept of futures began in early agricultural markets, where buyers and sellers would sign contracts to fix the quantity, price, and date of goods in advance to manage price volatility. The system took shape in 1848 when the Chicago Board of Trade was established. Futures are not physical goods but simply contracts to buy or sell goods. For creating a liquid market, futures contracts must meet specific conditions in a centralized trading market:1. Contract Standardization: Standard terms are defined for contracts to enable centralized bidding. 2. Daily Settlement: A daily clearing process managed by a clearinghouse reduces default risk. 3. Open Bidding: The contract price is determined through public bidding, enabling participants to make informed decisions based on the latest information.
Standardized contracts specify the asset's quality, contract value, pricing method, and settlement time to ensure all contracts are identical, except for price, facilitating competitive bidding and liquidity. For example, Taiwan stock index futures have contract months that span two continuous months from the trading month and include the March, June, September, and December quarterly months, totaling five contract months in the market. The underlying asset is the Taiwan Weighted Stock Index, with a contract value equal to 200 times the index, a minimum tick of one point (equivalent to 200 TWD), and cash settlement on all contracts. The daily settlement process adjusts the accounts at the close of each trading day based on the chosen closing price, deducting losses from the margin account and transferring gains to the respective accounts. If losses exceed a certain threshold (below the maintenance margin), additional funds must be deposited to cover the loss; otherwise, the position is forcefully closed.
Futures trading requires only a fraction of the contract value as a margin, offering high leverage. Futures can be divided into commodity futures and financial futures. Originally, futures were commodity-based, but financial futures now account for 78% of the market. Among financial futures, interest rate futures make up over 60%, stock index futures around 24%, and currency futures less than 10%.
| Stock Spot Trading | Stock Index Futures | |
|---|---|---|
| Transaction object | Individual company stocks | Major stock index |
| Holding Period | No fixed period | Cash-settled on the final trading day |
| Issuance Volume | Limited | Unlimited |
| Required Funds | Cash: 100%, Margin: 40% | 5%–15% of contract value |
| Settlement Time | T+2 for cash settlements | Daily settlement |
| Transaction Costs | 0.3% transaction tax on sale, 0.1425% service fee for each trade | 0.004% service fee for each trade, with transaction fees ranging from TWD 150 to TWD 200 per TX contract |
| Dividends | Yes | No |
| Flexibility | Limited by short-sell quotas and same-day cancellation restrictions | Allows same-day cancellation |
| Short-Sell Limit | Subject to short-sale quotas and restrictions below the flat market price | No short-selling limit |
| Financial Leverage | 1x for spot trading, 2.5x with margin | Around 10x |
Futures margin is a guarantee for contract fulfillment, unrelated to loans, while margin trading involves borrowing. Both provide financial leverage, but futures offer much higher leverage than stock margin trading.
For detailed product information, please refer to the Taiwan Futures Exchange website.detailed product information
Futures contracts have a defined expiration date, prompting arbitragers and hedgers to offset their futures and spot positions before expiration. Speculators also often manipulate the spot market to profit from futures, leading to greater volatility near expiration. For stock index futures, the settlement price on the final settlement day is calculated based on the simple arithmetic average of the underlying index within the last 30 minutes of trading on the Taiwan Stock Exchange. Consequently, the spot market's movement on the expiration and settlement days may be influenced by the different position holdings of index futures.
Stock index futures serve multiple functions: hedging, arbitrage, speculation, and price discovery, offering various advantages:
- Hedging Systemic Risk: Investors can short index futures to avoid systemic risks when holding stocks with upward potential in an unfavorable market environment.
- Simplified Trend Analysis: Futures eliminate stock-picking concerns as the underlying asset is simplified, allowing investors to focus on market trends. Investors expecting a rise in the stock market can use futures to increase leverage; in contrast, those expecting a decline can profit by shorting futures or hedging against stock market losses.
- High Leverage: With futures, traders need to deposit only 5%–15% of the margin, allowing for leverage of 10 to 20 times.
- Lower Transaction Taxes: The transaction tax on stock index futures is significantly lower than the 0.3% tax on stocks, making futures a more cost-effective trading option.
