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PUBLIC STANDARDIZED TRANSACTIONS

A private transaction is not generally reported in the news or to any price-reporting service. Forward contracts are private contracts. Just as in most legal contracts, the parties do not publicly report that they have engaged in a contract. In contrast, a futures transaction is reported to the futures exchange, the clearinghouse, and at least one regulatory agency. The price is recorded and available from price reporting services and even on the Internet.’ We noted that a futures transaction is not customized. In a forward contract, the two parties establish all of the terms of the contract, including the identity of the underlying, the expiration date, and the manner in which the contract is settled (cash or actual delivery) as well as the price. The terms are customized to meet the needs of both parties. In a futures contract, the price is the only term established by the two parties; the exchange establishes all other terms. Moreover, the terms that are established by the exchange are standardized, meaning that the exchange selects a number of choices for underlyings, expiration dates, and a variety of other contract-specific items. These standardized terms are well known to all parties. If a party wishes to trade a futures contract, it must accept these terms. The only alternative would be to create a similar but customized contract on the forward market.
With respect to the underlying, for example, a given asset has a variety of specifications and grades. Consider a futures contract on U.S. Treasury bonds. There are many different Treasury bonds with a variety of characteristics. The futures exchange must decide which Treasury bond or group of bonds the contract covers. One of the most actively traded commodity futures contracts is oil, but there are many different types of oil.’ To which type of oil does the contract apply? The exchange decides at the time it designs the contract. The parties to a forward contract set its expiration at whatever date they want. For a futures contract, the exchange establishes a set of expiration dates. The first specification of the expiration is the month. An exchange might establish that a given futures contract expires only in the months of March, June, September, and December. The second specification determines how far the expirations go out into the future. For example, in January of a given year, there may be expirations of March, June, September, and December. Expirations might also be available for March, June, September, and December of the following year, and perhaps some months of the year after that. The exchange decides which expiration months are appropriate for trading, based on which expirations they believe would be actively traded. Treasury bond futures have expirations going out only about a year, Eurodollar futures, however, have expirations that go out about 10 years.3 The third specification of the expiration is the specific day of expiration. Many, but not all, contracts expire some time during the third week of the expiration month.
The exchange determines a number of other contract characteristics, including the contract size. For example, one Eurodollar futures contract covers $1 million of a Eurodollar time deposit. One U.S. Treasury bond futures contract covers $100,000 face value of Treasury bonds. One futures contract on crude oil covers 1,000 barrels, The exchange also decides on the price quotation unit. For example, Treasury bond futures are quoted in points and 32nds of par of 180. Hence, you will see a price like 104 21/32, which means 104.65625. With a contract size of $100,000, the actual price is $104,656.25.
The exchange also determines what hours of the day trading takes place and at what physical location on the exchange the contract will be traded. Many futures exchanges have a trading floor, which contains octagonal-shaped pits. A contract is assigned to a certain pit. Traders enter the pits and express their willingness ta buy and sell by calling out and/or indicating by hand signals their bids and offers. Some exchanges have electronic trading, which means that trading takes place on computer terminals, generally located in companies’ offices. Some exchanges have both floor trading and electronic trading; some have only one or the other.