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Define a futures contract and its key specifications, covering delivery, limits, open interest, trading volume, contract size and price, and the underlying asset.

FRM® Part I · Financial Markets and Products · Futures Markets · FRM1.FM.7.a

The idea

A futures contract is a standardised agreement, traded on an exchange, to buy or sell a specified underlying asset at a price fixed today for delivery or settlement at a set future date. The exchange fixes the underlying and its grade, the contract size (for example 1,000 barrels or 5,000 bushels), the delivery months and location, and the price quotation unit. It also sets the daily price limit, which caps how far the price may move from the previous settlement in one session. Volume counts the contracts traded in a period. Open interest counts contracts still outstanding, with each long-short pair counted once. A trade that opens both sides raises open interest, one that closes both lowers it, and a mixed trade leaves it unchanged. Exam traps are confusing volume with open interest and ignoring the contract size when sizing exposure.

A practice question

From the question bank, with the reason each wrong option is wrong.

Which statement correctly defines open interest in a futures contract?

  1. The number of contracts traded during the trading day by all buyers and sellers combined.Why not: Describes trading volume, which counts every trade in a period and not the positions still open.
  2. The number of contracts outstanding that have not been closed out by an offsetting trade or settled by delivery. - correct
  3. The sum of all long positions and all short positions outstanding.Why not: Counts each contract twice; open interest counts a long-short pair once.
  4. The number of contracts that were delivered by shorts to longs at the most recent expiry.Why not: Confuses open interest with deliveries; open interest covers positions still alive, not those settled.

Open interest is the number of contracts outstanding, counting each long-short pair once. Volume counts trades in a period, and delivery quantities are a small subset of earlier open interest.

A harder one

A crude oil futures contract is for 1,000 barrels and is priced at USD 78.40 per barrel. A trader buys 15 contracts and the initial margin is 6% of the notional. What is the notional value of the position?

  1. USD 1,176Why not: Multiplies the price by the number of contracts but omits the contract size of 1,000 barrels.
  2. USD 78,400Why not: Values only one contract, ignoring the 15 contracts bought.
  3. USD 70,560Why not: Reports the initial margin (6% of notional) rather than the notional exposure of the position.
  4. USD 1,176,000 - correct

Notional = price x contract size x number of contracts = 78.40 x 1,000 x 15 = USD 1,176,000. The margin of USD 70,560 is only the cash deposit, not the exposure.

The hardest tier

A grain futures contract is for 5,000 bushels with a daily limit of USD 0.60 per bushel. The previous settlement was USD 12.40, and the market closes locked limit-up at USD 13.00, while a later free-market quote implies USD 13.30 would have been fair. A trader is short 20 contracts. What is the variation margin movement on the short position for the day?

  1. A debit of USD 90,000Why not: Uses the unobserved free-market price of USD 13.30; daily settlement uses the settlement price, which is capped by the limit.
  2. A credit of USD 60,000Why not: Gets the sign wrong: a short loses when the price rises, so the account is debited.
  3. A debit of USD 60,000 - correct
  4. A debit of USD 3,000Why not: Applies the move to one contract only (0.60 x 5,000) and ignores the 20 contracts held.

The settlement price rose USD 0.60, so the short loses 0.60 x 5,000 x 20 = USD 60,000, debited from the margin account. The limit restricts the daily move, so the economic loss beyond it is deferred, not recorded.

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