A gold futures contract buys gold for future delivery.
A futures contract on HSBC stock has the HSBC shares as the
underlying commodity. But what does a Stock Index Futures
(SIF) contract buy or sell?
In theory, the commodity underlying an SIF contract is a
portfolio of stocks replicating the specified index. The
best way to understand what this means is to see how an SIF
contract can be used by the investor to profit from his
views on broad market movements. In this article, we shall
use the soon-to-be-launched Simex MSCI Singapore Stock Index
Futures (or SiMSCI Futures for short) for illustration.
The exact specifications of SiMSCI Futures are yet to be
finalised. What is known at present includes the following.
The contract assigns a $200-per-point value to the
underlying MSCI Singapore Free Index. (This index will be
explained in greater detail in a subsequent article.) There
will be six contract months concurrently listed for trading.
The margin requirements will be approximately 10% of the
contract value. The MSCI Singapore Free Index stood at 190.9
on 8 May 1998. The corresponding SiMSCI Futures would have a
contract value of $38,180, being $200 times 190.9. In this
series, we will assume that the initial margin and the
maintenance margin for this contract are $5,000 and $4,000,
respectively. Note that they are two specified levels of the
same margin account, not two separate sums of money.
When two counter-parties trade SIF futures, the buyer is
betting that the index up to a specified point in time will
be above a certain level. The seller, on the contrary, holds
the opposite view. The "specified point in time" is the
maturity date of the futures contract. Futures are
standardised contracts. The standardised maturities of the
SiMSCI Futures will be the last Stock Exchange of Singapore
(SES) trading day of the contract months, being the two
nearest serial months and the nearest March quarterly months
(meaning, in August 98, the following four months: September
98, December 98, March 99, June 99). As a near contract
(say, September 98) matures, a distant contract (i.e.,
September 99) will be added on a rolling basis.
Without an SIF futures contract, an investor who is
bullish about the overall market movement and wishes to take
a position accordingly will have to pick the counters to
invest in. To form a portfolio broad enough to represent the
overall market would definitely require millions of dollars,
quite possibly beyond his budget. If he selects just a few
counters, his choices may not move in tandem with the broad
market.
On the other hand, a bearish investor who does not hold
shares will have no way of putting his money where his
belief is since shortselling is not allowed. An investor
with shares can sell off the shares before the anticipated
market downturn. However, it is possible that although his
broad market view proves to be correct, some of the shares
he has sold buck the market trend.
With SIF contracts, such a dilemma can be easily
resolved.
Suppose Mr Tan believes that the MSCI Singapore Free
Index will be above 180 by 30 September (the last SES
trading day for September) and buys a SiMSCI Futures
September contract on 24 August at a price, say, 180.0. Mr
Tan is now "long" in one SiMSCI Futures contract. He must
have $5,000 in his margin account for his long position,
assuming that the initial margin and the maintenance margin
his broker requires of him are $5,000 and $4,000,
respectively. (Tan's broker cannot lower the margins below
the minimum levels set by Simex. The broker, however, has
the discretion to impose higher margin requirements.)
At the end of each trading day, the exchange will
determine the settlement price for each contract. Suppose
the settlement price so determined at the close of 24 August
trading is 182.4. Compared with Tan's purchase price of
180.0, this means a 2.4-point gain, or $480 profit (since
each point is worth $200).
Unlike holding shares where profits are merely on paper
(i.e., not realised) unless the shares are sold, futures
positions are "marked to market" on a daily basis, with the
settlement price taken as the market price. As such, Mr
Tan's margin account will be credited $480 for the 24 August
settlement, resulting in a $5,480 balance in his margin
account.
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