a primary focus. In any case, it is alwayspreferable to be adequately prepared than to react at the last minutewith the risk of missing the point.
3F UTURES AND R ELATEDI NSTRUMENTS
INTRODUCTIONIn the same way that we opened the previous chapter with anoverview of the world equity capitalization, we will open this chapterby examining the biggest markets with respect to futures liquidity. Theadequate measure here is not capitalization anymore because we focuson derivatives, but rather outstanding position or open interest. Theopen interest indicates the number of contracts outstanding at a giventime, and it suits our purpose perfectly.Figure 3-1 presents the total open interest converted in U.S. dollarsover the last ®ve years of the Nikkei 225, DAX 30, FTSE 100, CAC 40,and S&P 500 futures. The U.S. market is undoubtedly dominant againwith respect to futures trading, and indeed the ratios between thedifferent open interests are of the same order of magnitude as for theexchanges' relative capitalization. For example, the open interest forthe S&P 500 futures at the end of 1999 was around 10 times that of theCAC 40.If we take a broader perspective, however, the situation changesslightly. First, these contracts are not the most liquid by far becauseequity futures are traded much less actively than interest rate productsin general. For example, the eurodollar futures in Chicago have anaverage daily volume of $368.7 billion, and they had an averageopen interest of $2,976.4 billion in 1999, more than 20 times that ofthe S&P 500. Indeed, this situation is true on a larger scale and onoptions as well, as shown in Table 3-1.107
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108THEORY AND TOOLS
Figure 3-1 Open Interest(Source: Compiled by author from Datastream data.)
The nominal data have been calculated using a monthly exchange rate. At year-end 1998, 1USD  5.8262FRF, 1USD 112.8JPY, 1USD  1.6656DEM, 1USD  0.6011GBP.To be representative of total interest on the index, the Nikkei 225 futures open interest includes both the Japanesecontract listed in Osaka (OSE) and the Singapore contract (SIM).
CHAPTER 3 FUTURES AND RELATED INSTRUMENTS
109
TABLE 3-1 Derivative Financial Instruments Traded on Organized Exchanges byInstrument and Location (Notational principal in billions of U.S. dollars)Amounts Outstanding
Instruments/Location
Turnover
1997Dec.
1998Dec.
1999Sept.
1999Dec.
1998Year
1999Year
1999Q1
1999Q2
1999Q3
1999Q4
7,752.77,489.251.9211.53,233.93,082.648.5102.92,550.32,496.21.153.11,928.91,876.10.152.839.634.42.32.9
8,061.27,702.238.1321.03,536.83,365.338.9134.72,914.12,788.40.3127.51,581.21,523.90.157.229.026.70.81.5
8,958.28,605.144.6308.53,651.73,468.140.4143.22,842.72,759.00.783.02,283.62,203.40.879.4180.2174.62.72.8
8,266.87,897.336.5333.13,550.63,357.332.0161.32,371.42,274.20.696.72,146.62,073.01.172.4198.3192.92.82.8
318,611.0294,792.63.068.420,750.1151,928.1139,326.02,868.79.733.3117,396.1109,134.510.28,251.547,285.644,797.13.82,484.72,001.21,534.9185.7280.5
287,958.2283,718.12.573.221,666.9134,258.0120,681.62,239.111,337.4104,547.698,088.19.18,452.347,114.243,341.114.83,758.32,038.41,607.4310.2118.9
72,872.287,068.1609.25,194.933,612.930,355.7542.82,714.427,948.128,259.10.41,688.610,886.710,120.00.6766.2424.5333.465.425.7
76,421.670,492.4648.45,280.836,737.133,319.6566.52,851.027,178.425,737.21.21,440.011,994.511,035.21.6957.7511.6400.479.032.1
78,840.770,848.0715.85,278.734,622.731,227.2615.02,780.528,309.526,743.54.11,561.913,370.612,455.25.8909.8537.9420.191.126.7
61,821.855,309.8599.75,912.529,285.325,779.1514.82,991.421,111.619,346.43.41,761.810,862.59,730.76.91,124.9562.4453.474.634.4
4,449.63,839.833.2776.53,092.62,438.532.1621.91,037.1917.60.2119.3301.0279.5Ð21.518.94.20.913.8
5,487.94,602.818.7866.53,780.93,123.718.3639.01,497.81,309.9Ð187.8196.5187.5Ð28.013.71.70.411.8
5,755.04,352.831.81,370.43,572.02,458.318.81,094.91,915.11,695.40.5219.3238.6196.3Ð42.329.22.812.513.9
5,234.23,754.722.41,457.23,380.82,259.313.11,108.51,581.21,299.90.5280.9234.8191.10.143.737.34.58.724.1
69,088.155,480.4397.813,209.947,605.538,599.1379.58,626.917,225.514,152.40.93,072.23,998.52,590.9Ð1,407.7258.5138.017.4103.1
62,042.845,625.7289.018,128.141,166.529,745.0219.911,201.616,955.214,034.12.02,919.13,623.21,796.80.61,825.8297.949.966.4181.8
18,268.812,850.370.43,346.210,899.98,435.356.62,408.14,438.63,873.50.3584.7687.3533.7Ð353.641.07.813.419.8
16,805.212,709.670.04,025.511,523.18,534.854.12,934.24,254.13,641.00.3612.8959.2518.30.1440.868.815.615.537.8
14,860.110,772.281.84,008.19,546.78,731.761.72,753.34,355.43,601.20.6753.7881.2428.70.3452.276.710.619.146.9
14,110.79,293.868.84,750.29,196.76,043.247.53,106.03,907.12,918.40.7987.9895.5316.10.2579.2111.415.918.477.1
FuturesAll markets .................Interest rate .............Currency ..................Equity index .............North America ............Interest rate .............Currency ..................Equity index .............Europe .........................Interest rate .............Currency ..................Equity index .............Asia and Paci®c .........Interest rate .............Currency ..................Equity index .............Other Markets .............Interest rate .............Currency .................Equity index .............OptionsAll markets .................Intrerest rate ............Currency .................Equity index .............North America ............Interest rate .............Currency ..................Equity index .............Europe ....... .................Interest rate .............Currency ..................Equity index .............Asia and Paci®c .........Interest rate ..............Currency .................Equity index .............Other Markets .............Interest rate .............Currency ..................Equity index .............
(Source: Bank of International Settlements, Statistical Annex to the Quarterly Review on International Banking and Financial MarketDevelopments, February 2000.)
110
THEORY AND TOOLS
The second interesting point is that in terms of contract turnover,the United States is in fact far behind Europe, as shown in Table 3-2.Among possible explanations for this situation is the fact that futurescontracts in Europe tend to have a smaller size than they have in theUnited States. In any case, the German derivative exchange, Eurex, hassince 1999 become the most active exchange in the world, in front of theCBOT with 379 million versus 255 million contracts traded, as shownin Figure 3-2.Finally, for the sake of completeness, let's take an even broaderperspective and replace these ®gures in the overall market for futurestrading, as shown in Table 3-3. Financial futures are clearly dominantin the marketplace compared to agricultural or commodity futures,expanding from 59.5 to 65.5 percent of the aggregate open interest inthe United States.
DEFINITIONSA futures contract is a binding agreement between two parties toexchange certain goods, at a certain price, known on the day the transaction is effected and called the futures price, at a certain date in thefuture, known as the expiration or expiry date.1 When the goodsexchanged are monetary ¯ows, the futures contract is said to have acash settlement and is quali®ed as a ®nancial futures.Consider, for example, a transaction on a corn futures contract.2 Byconvention, the buyer of the contract is the party receiving the goodsupon delivery, against payment. The terms of the contract include itsmain characteristicsÐnamely, the quantity and price of corn deliverable and the date of the delivery. Before that date, no exchange whatsoever is necessary between the parties. On expiry, the buyer pays forthe corn and the seller delivers it.For contracts listed on an exchange, the terms are standardizedand include several more parameters, for example, the grade and1
The expiry date is the day on which the claim on the underlying goods becomeseffective. Actual delivery usually follows by a few days, and the exact date onwhich it occurs is called the settlement date or delivery date depending on the context.2Commodity futures are indeed a classic example because they were the ®rst futuresdeveloped in history. This explains why Chicago, which has long been an importanttrading center in the midwest, imposed itself as a ®nancial center as well very early on.It now houses the most important derivative exchanges in the United States and in theworld.
CHAPTER 3 FUTURES AND RELATED INSTRUMENTS
111
TABLE 3-2 Derivative Financial Instruments Traded on Organized Exchangesby Instrument and Location (number of contracts in millions)Contracts Outstanding
Turnover
1997Dec.
1998Dec.
1999Sept.
1999Dec.
1998Year
1999Year
1999Q1
1999Q2
1999Q3
1999Q4
All markets ................Interest rate ............Currency ................Equity index ...........North America ...........Interest rate ...........Currency ................Equity index ............Europe .....................Interest rate .............Currency .................Equity index ...........Asia and Paci®c ........Interest rate ............Currency .................Equity index ............Other Markets ...........Interest rate ............Currency .................Equity index ............
23.419.42.02.05.24.30.40.56.95.01.40.53.62.8Ð0.87.87.30.30.2
20.717.30.82.65.54.60.30.56.24.70.41.13.12.2Ð0.96.05.70.10.2
22.318.20.63.55.74.70.40.56.14.30.11.74.03.0Ð1.06.56.10.10.3
21.317.50.73.15.44.50.30.66.53.60.21.63.32.5Ð0.77.16.80.10.2
992.5760.054.5178.0357.7287.927.042.8423.1345.18.968.2128.476.70.149.685.349.418.817.4
914.7672.737.1204.9319.9248.623.947.5417.9322.91.893.4115.865.90.349.561.135.211.414.5
231.6168.48.754.583.966.88.011.1106.678.60.427.528.616.1Ð12.512.56.92.33.4
237.8178.49.549.985.968.06.311.8105.984.80.421.030.917.5Ð13.315.28.32.84.0
238.6178.010.250.580.761.96.312.5111.188.30.222.530.318.20.112.016.89.53.53.5
206.6147.98.849.969.552.05.312.294.371.40.522.428.014.10.111.716.810.32.93.8
Memorandum Items:Commodity ContractsU.S. markets ...........Other markets .........
6.12.73.4
6.32.83.5
7.13.33.8
6.52.93.6
306.9153.4153.4
327.5165.6162.0
82.040.241.8
81.541.739.8
86.844.941.9
77.238.738.6
All Markets ................Interest rate ............Currency .................Equity index ............North America ..........Interest rate ............Currency .................Equity index ............Europe ........................Interest rate ............Currency .................Equity index ............Asia and Paci®c ........Interest rate .............Currency .................Equity index ............Other Markets ...........Interest rate ............Currency .................Equity index ............
17.46.02.49.07.83.40.43.95.62.00.13.51.00.5Ð0.53.00.11.91.1
17.46.90.99.88.64.50.23.86.02.1Ð3.90.80.2Ð0.62.1Ð0.71.4
27.46.70.720.18.83.70.24.815.82.7Ð13.11.10.2Ð0.91.80.10.51.3
27.15.60.521.07.53.20.14.216.32.1Ð14.11.00.2Ð0.82.20.10.31.8
336.8129.712.1195.0172.386.15.480.7102.837.40.465.044.84.5Ð40.117.11.76.39.2
447.3118.06.8322.5142.972.22.867.9186.841.70.1144.991.93.00.188.826.71.03.820.9
102.231.51.669.139.321.10.817.437.79.3Ð28.420.00.9Ð19.05.20.20.84.3
110.832.51.676.838.320.90.716.643.110.5Ð32.722.60.9Ð21.76.80.30.85.6
111.428.21.981.334.416.40.817.248.110.9Ð37.222.90.7Ð22.26.00.21.14.7
122.925.71.795.531.013.80.518.757.711.1Ð48.828.50.5Ð25.97.70.31.16.3
Memorandum Items:Commodity ContractsU.S. markets ...........Other markets .........Single Equity ContractsU.S. markets ...........Other markets .........
2.72.40.343.831.512.3
2.72.40.368.244.723.5
4.13.60.5128.991.935.0
3.63.10.6169.4121.937.5
38.632.54.1501.4325.8175.7
41.435.55.9700.3443.8256.6
9.07.81.3158.095.762.4
9.78.31.4165.4100.065.4
12.110.61.5167.2105.561.8
10.68.81.9209.7142.687.1
Instruments/LocationFutures
Options
(Source: Bank of International Settlements, Statistical Annex to the Quarterly Review on International Banking and FinancialMarket Developments, February 2000.)
112
THEORY AND TOOLSVolumes on Major ExchangesIn millions of contracts traded
40019981999300
200
100
Eurex
CBOT
CBOE
CME
MATIF
LIFFE
0
Figure 3-2 Future Exchanges(Source: Bank of International Settlements, Quarterly Review on International Bankingand Financial Market Developments, February 2000.)CBOE: Chicago Board Options Exchange; CBOT: Chicago Board of Trade; CME:Chicago Mercantile Exchange; LIFFE: London International Financial Futures andOptions Exchange; MATIF: MarcheÂ aÁ Terme International de France.
quality of the corn and the delivery location. As a general rule,futures contracts on commodities are worded in such a way as toreduce ambiguities to a minimum and allow all transactions to beeffected on a single fully fungible underlying. In fact, this necessitygoes beyond commodity futures to all futures with a physical delivery, which is, for example, the case for futures on U.S. treasurybonds. The bonds acceptable for delivery are clearly speci®ed inthe terms of the contract.Therefore a futures contract is really nothing more than a simpledeferred transaction, but:. On expiration day, if we assume that corn can always be bought for
immediate delivery at any time, the futures contract does not provide any bene®t compared to cash cornÐthat is corn bought for adelivery the same day.3 At that time, nobody would be ready to
3
We assume here that corn bought today can be delivered today. This is naturally asimpli®cation because of the difference between operation date and settlementdate.This is the very ®rst important characteristic of a futures contract: To price it,we must constantly refer to the price of the underlying commodity. Futures arederivative products, and their existence is subordinated to the existence of a cashmarket for the underlying.
CHAPTER 3 FUTURES AND RELATED INSTRUMENTS
113
TABLE 3-3 FuturesÐAverage Month-End Open Interest, Number of Contracts Traded,and Number of Contracts Settled by Delivery or Cash Settlement by MajorGroups, All Markets Combined, FY 1993±FY 1999FiscalYear
Total
Grain
OilseedProducts
LivestockProducts
Average Month-End Open Interest (In Contracts)19935,164,957365,751301,492116,64019946,508,063422,468323,368125,66419956,434,175502,955332,115118,66419966,671,956594,283383,027149,11019977,035,190484,878378,005158,5548,734,778561,318419,055156,097199819998,927,497581,590420,159178,617
OtherAgriculturals
Energy/WoodProducts
292,869328,149357,332357,039399,845425,208395,387
697,275807,177695,734707,515793,050969,2741,140,329
5,770,8356,137,1056,238,5097,048,5347,550,5567,385,5697,438,875
10,754,86412,318,57212,744,90112,018,52213,190,75514,039,61513,753,993
42,841,81350,460,60747,944,15346,891,52451,512,41981,705,14672,941,784
Number of Contracts Settled by Delivery/Cash Settlement19932,082,97048,573179,28411,69519942,873,45476,73788,7418,36819952,995,95870,548158,00312,90019962,890,18738,228172,44213,38419973,559,07936,589148,70329,88319984,186,908131,357116,41242,23019993,631,918120,775106,36444,129
56,84044,37360,59339,40638,01531,82832,282
62,74478,10875,20987,777119,505129,586131,905
Number of Contracts Traded1993325,515,261 16,006,1041994411,056,929 19,970,0081995409,420,428 21,093,0861996394,182,422 30,217,4421997417,341,601 25,507,4981998 500 ,676,345 28,139,0491999491,137,790 26,860,264
20,738,24520,988,31820,687,82025,591,70327,132,48326,854,24525,625,245
Metals314,4