Futures Lesson 3: Day Trading Day 3

Overview of Expiration and Settlement

Expiration
Every futures contract has a specific expiration date. Before it expires, traders can either:

• Close out their position (end the trade early)

• Extend their position (continue the trade longer)

However, some traders choose to hold onto the contract until it expires, leading to settlement.

Settlement
Settlement is when the terms of the contract are fulfilled. There are two main types of settlement:

1. Physical Delivery: This is when the actual product is delivered. For example, a food producer might receive physical corn or wheat from a farmer who delivers it. While this is important for some products like energy, metals, and agriculture, most futures contracts don't result in physical delivery.

2. Cash Settlement: This is more common. Instead of delivering a product, the contract is settled by a payment or deduction based on its value at expiration. For example, equity index, interest rate, and many other contracts (like foreign exchange or some agricultural products) are settled this way.

Which type of settlement happens depends on the trader’s needs and the product being traded.

Some terms to know:

• Liquidity: This refers to how quickly and easily you can buy or sell a contract without affecting its price. A market with good liquidity means you can get in and out of trades easily.

• Bid-Ask Spread: This is the difference between the price someone is willing to pay (bid) and the price someone is willing to sell (ask). A smaller spread means there’s less cost for traders to enter or exit positions.

• Tick Size Importance: If the tick size is too big, it can make price movements feel "jumpy," and small price changes could be missed. If it’s too small, trading can become too slow, making it harder to profit from small movements.

How to Calculate Tick Size

To calculate the tick size, you need to know two things:

1. The smallest price movement allowed by the exchange (this is the tick, often in points or cents).

2. The contract size (how much of the asset is in one futures contract, like barrels of oil or bushels of corn).

Basic Formula:

Tick Size = Minimum Price Movement × Contract Size

Example 1: E-mini S&P 500 Futures Contract

• Minimum Price Movement: 0.25 points (this is set by the exchange).

• Value of 1 index point: $50 (also set by the exchange).

To calculate the value of 1 tick:

Tick Value=0.25×50=12.50Tick Value=0.25×50=12.50

So, each 0.25-point movement (1 tick) is worth $12.50.

Example 2: NYMEX WTI Crude Oil Futures Contract

• Minimum Price Movement: 0.01 (1 cent).

• Contract Size: 1,000 barrels (each contract represents 1,000 barrels of oil).

To calculate the value of 1 tick:

Tick Value=0.01×1,000=10Tick Value=0.01×1,000=10

So, each 1-cent movement (1 tick) is worth $10.

General Tips for Beginners:

1. Tick Size Varies by Contract: Every futures contract has a different tick size based on the asset and contract size.

2. Always Check the Product Specs: Exchanges like CME Group list the tick size and contract specifications for each product on their website.

3. Smaller Ticks = More Precision: A smaller tick size allows for finer price movements and potentially better trading opportunities, but it can also mean more frequent price changes.

Steps for Finding Tick Size:

1. Look up the minimum price movement for the specific contract on the exchange’s website.

2. Find the contract size for the asset being traded.

3. Multiply them together to get the tick size or value.

This makes it easy to figure out how much each tick is worth when trading futures!