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Futures Technology 1630A 30th St # 365 Boulder, Colorado 80301 1-800-878-6070 303-442-6543 |
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CLEARING OPERATIONS Clearinghouses of the U.S. Commodity Exchanges are responsible for the day-to-day settlements of thousands of accounts. Their operations ensure the financial integrity of the marketplace and have made possible, as much as any other area of exchange operations, the rapid growth and efficiency of futures trading. The essence of modern clearing practices is that a financially sound clearing organization backed by exacting procedures stands as a party to every trade. Both buyers and sellers of futures contracts and of options on futures contracts are responsible to the clearinghouse through member firms of the clearinghouse. Each day the clearing corporation settles all accounts to a net gain or loss and balances its own books to a net zero position. Gains are paid out to the accounts of member firms; losses require the deposit of additional funds before the opening of the next day’s market. EARLY SETTLEMENT METHODS In the mid to late 1800’s, it was common for the buyers and sellers of commodities to arrange for their deferred delivery and later meet to exchange goods and payment. As the volume of trading grew, brokers assumed importance in dealings for buyers and sellers, making agreements, arranging for the delivery of goods, and transferring the funds in return for a commission fee. At the time, most trading on commodity exchanges was cash for "spot" delivery and payment, or cash transactions which called for deferred delivery. THE RING METHOD Increasing use of exchange markets by commercial firms and speculators led to such expanded volume of trading that direct transactions between buyer and seller became unfeasible. One contract might be bought and resold several times. To handle this complex chain of transactions, the settlement clerks of brokerage houses maintained the daily accounting for all their customer transactions. This method of keeping track of their records, kept in ring books, became known as the "ring" method. Suppose that a broker received a new order from a customer, John, to buy wheat futures contracts. The broker executed the order with Robert; his settlement clerk’s records showed that John bought from Robert. Later, John, seeing a profit on a price increase, decided to liquidate by selling back the same number of wheat futures contracts. John gave an order to that effect to that effect to his broker. John’s contracts were offered on the market. They were bought by a man named Brad. Suppose that Brad wished to liquidate his obligation two days later because of a price decline and the desire to cut his losses. His contracts were offered in the market. Lets assume that they were bought by Chris, a flour miller, who wanted to take delivery of the wheat when the contract reached maturity. His broker arranged for the delivery and payment between Chris and the original seller of the contracts, Robert. Any obligation that had been undertaken by John or Brad would have since been offset, liquidated by their equal and opposite futures transactions. Often this kind of chain of buyers and sellers involved as many as 50 or more parties. 1: Robert-Sold to John <-----------------------------> 4: Chris-Delivered to Robert
2: John - Sold to Brad <-------------------------------> 3: Brad - Sold to Chris As futures contracts developed, speculators and commercial uses found that it was, at times profitable to liquidate their futures contracts obligations by offsetting them with equal and opposite transaction, rather than by taking or making delivery. A buyer of futures contracts could offset his obligation to take delivery of the commodity by selling an equal number of futures contracts, thereby shifting the obligation to take delivery to another party. Sellers who decided not to deliver commodities against the contracts would offset the obligation to do so by buying an equal number of futures contracts. The ability to deliver or take delivery of the commodity was secondary to the risk-management potential or the financial leverage that futures contracts provided. Commercial firms with inventories found that they could take a short position in futures to protect against losses, offset their obligation to deliver through an equal and opposite transaction, thus having the choice of selling their cash commodities when and where they could get the best price with a minimum of transportation cost. Speculators, with no commercial involvement in the actual commodities, found that a futures position could be liquidated through an opposite futures transaction, avoiding the expense and risk of owning the cash commodity. FORMAL CLEARING ORGANIZATION The ring method of settlement served the futures markets well from the early 1900’s until the 1920’s when the first formalized clearing operations were developed, either as part of an exchange, or as a related but separate corporation, a fully chartered entity. Today, clearing of futures contracts on U.S. Commodity exchanges is still conducted by separate clearing corporations or by clearinghouse divisions of the exchanges. THIRD-PARTY GUARANTORS Clearinghouses and clearing corporations act as third parties to all futures contracts and options on futures contracts, acting as buyer to every seller and seller to every buyer. Buyers and sellers of commodity futures and option on futures contracts do not create financial obligations to one another, but rather create obligations to the clearing corporation through its member firms. A transaction in which Chris sells futures through ABC brokerage to XYZ brokerage for the account of Tom obligates ABC to the clearing organization to perform under the terms of the contract , either to make delivery or to offset through an opposite and equal purchase of futures prior to the end of the trading period. In this way, the clearing corporation acts as seller to the buyer at delivery. CLEARING MARGINS One of the most important financial safeguards in assuring performance on futures contracts is the clearing margin that clearing member firms must maintain against their position in each commodity. These margins are set by the clearing corporation margin committee and directors. They are distinct from the margins that individual holders of commodities accounts are required to deposit with their brokers by exchange regulations. One the Chicago Board of Trade and most other exchanges, each clearing member’s initial clearing margin deposits are made in relation to the net long or short position in each commodity. Long Position is the buy side of a trade; Short Position is the sell side. A clearing member firm with a selling or short position of (10) Corn futures contracts, and a buying or long position of (5) Corn futures contracts, would be required to deposit margin money on the net short position of (5) Corn contracts. If you put on a position where the clearinghouses is the Chicago Mercantile Exchange and the New York Mercantile Exchange you would require a margin deposits on both the long and short positions in each commodity rather than on the net position. (For options on futures contracts, however, margin is only required from the net short position.) Original margins are usually the same for all clearing members, although, the directors are empowered to increase them in situations where particular risks develop. In the interest of producers and consumers, as well as users of futures markets, the clearing organization attempts to keep margins as low as possible, consistent with markets risks. Clearing margins may be posted in four forms or in combinations of these - CASH, evidenced by bank-issued margin certificates; INTEREST-BEARING obligations of the federal government; STOCK in the clearing corporation; and LETTER OF CREDIT issued by an approved bank. This money cannot be touched by the member firm until it is released by the clearing corporation. As a member’s position changes from day to day, so does his required margin. One basic computation of the clearing corporation is the margin requirement for every clearing member after each trading session. A margin statement is provided each evening. In the event the net position increases, additional margin must be deposited before the opening of the next day’s market. When the net position in a commodity declines, excess margin money may be returned to the clearing member firm. Some firms prefer to keep surplus margin in reserve rather than draw it back on a daily basis. Normally, initial margins are sufficient to cover daily maximum price fluctuations. When market prices move against a member’s position, however, his standing margin is reduced to the extent of the price-change. The clearing corporation can call on a member to deposit additional margin money at any time within a trading session to cover adverse price changes. This is known as a variation margin call, and the member must pay the amount called for by wire transfer of funds within one hour. This amount is applied to the settlement for the day and does not go into the standing or initial margin account. In this way, the clearing corporation maintains very tight control over margins as prices fluctuate. It assures that sufficient margin money will be on deposit at all times¾ another means of assuring the integrity of futures contracts. DAILY SETTLEMENT OF ACCOUNTS Each day the clearing corporation settles every account on its books. All futures accounts, long or short, whether traded during the most recent session or not, are adjusted daily as to gain or loss. The basis of adjustment is the difference between each delivery month’s settlement price and the price at which a contract was made. In the case of options on futures, the full premium is received from the buyer and passed on the seller. Options trades are not marked to the market daily. Although different exchanges use varying methods to determine the settlement price, the following examples are the most common. When there is no range of closing prices, but only a single price at the close of trading, that price becomes the settlement price. However, it is common in the flurry of last-minute trading for several separate transactions to be made at closely related but different prices. The most common means of determining the settlement price is a simple average of the high and low prices in the closing range. MARKET INFORMATION Daily recording of volume and open interest information is a basic service of the clearing corporation, performed for the exchange. Both volume, the number of contracts traded in each delivery month of every commodity, and open interest, the number of contracts not yet liquidated nor fulfilled by delivery for all delivery months in each commodity, are significant measures of the likely volume of trade for future sessions when analyzed in relation to price movement. According to the provisions of the Commodity Futures Trading Commission Act of 1974, all commodity exchanges are required to make available , on a daily basis, volume and open interest data for each commodity and delivery month and each option on a futures contract and its expiration date. This information forms the basis for the CFTC’s monthly report analyzing open interest and commitments of all traders according to the size of account and whether it is speculative or commercial. Both the daily and monthly reports on volume and open interest are published in print media as an information service to interested parties. MEMBERSHIP FINANCIAL REQUIREMENTS The exacting day-to-day procedures for settling accounts, clearing liquidated trades, collecting and maintaining original and variation margin moneys, regulating the delivery of commodities in satisfaction of futures contracts, and reporting trading data represent only part of the efforts of clearing corporations to assure financial integrity in the marketplace. These efforts begin with rigid requirements for membership in the clearing corporation. Unlike memberships on the commodity exchanges, which are held by individuals only, membership in clearing organizations is normally held by companies. On the memberships rosters of clearing corporations are international commission firms, commercial processors of commodities with subsidiary divisions to handle public customers’ accounts, commission houses that handle only commercial accounts, and firms that handle combinations of these types of business. On some exchanges, individuals may apply for clearing privileges, but they are restricted to the clearing of trades solely for their own accounts rather than for customer business. The level of capitalization required for clearing member firms or prospective members varies with the type or size of the business operation and attendant risks. Some clearing corporations require that members purchase and hold specified numbers of shares in the corporation. Financial requirements for clearing members firms vary among the exchanges but are uniformly rigid to help ensure the financial soundness of the clearinghouses and clearing corporations. The clearing operations of U.S. commodity exchanges are among the most important exchange functions in assuring the financial reliability of the exchanges and the efficiency of futures markets. DELIVERY All futures contracts are ultimately settled either by liquidation through offsetting purchases or sales, or delivery of the physical commodity against the contract. The vast majority of futures contracts are settled by offset. Only one to three percent of all futures contracts result in delivery on the actual commodity. Yet the fact that buyers and sellers can take or make delivery is essential to the functions of futures markets. The ability to make or take delivery of the actual commodity assures that futures prices will reflect the actual cash value of the commodity. Clearing corporations do not make or take delivery of commodities themselves. Rather they provide the mechanism that enables sellers to make delivery to qualified buyers. Delivery procedures vary somewhat from exchange to exchange. The following procedures used by the Clearing Corporation of the Chicago Board of Trade are generally representative of the delivery process for most commodities and most clearing operations in general, a seller wishing to deliver on a futures contract must file a Notice of Intention to Deliver with the clearinghouse. This notice is evidence of his or her intent to make delivery on the next business day, which is commonly referred to as First Notice Day and occurs on the business day prior to the first delivery day of the expiring contract month. The Clearing Corporation begins to prepare for the delivery process two business days prior to the first delivery day. On that day, each clearing member firm with open long positions must submit a Long Position Report to the Clearing Corporation showing all long positions and the dates they were initiated and initialed by customers of the house. On the following day, the Clearing Corporation assigns deliveries to clearing member firms. Delivery notices are first issued to firms having the oldest long positions. The delivery and payment take place on the following business day, known as Delivery Day. Payment upon delivery is made at the settlement price of the day preceding the issuance of the notice of intention to deliver. Invoicing includes adjustments for any premiums or discounts for quality differentials, and any changes for storage or other services. The clearing member firm buying, taking delivery, pays the clearing member firm selling, making delivery.
The Rules and Regulations of the different Commodity Exchange should be consulted as the authoritative source for information, rules and contract specifications. PLEASE NOTE THAT THERE IS AN INHERENT RISK OF LOSS ASSOCIATED WITH TRADING FUTURES AND OPTIONS CONTRACTS. EMPLOYEES OF FUTURES TECHNOLOGY, LLC PROVIDE INFORMATION BASED ON SOURCES WE CONSIDER RELIABLE, BUT THERE IS NO GUARANTEE THAT THE INFORMATION WE PROVIDE WILL RESULT IN PROFITABLE TRADES. PLEASE CAREFULLY CONSIDER YOUR FINANCIAL CONDITION BEFORE INVESTING IN FUTURES AND OPTIONS CONTRACTS. FUTURES TRADING IS NOT SUITABLE FOR ALL INVESTORS. PAST PERFORMANCE IS NOT NECESSARY INDICATIVE OF FUTURE RESULTS. This Site is Designed, Built and
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