Futures Investment - Theory and Practice

Author: Zhu Guohua, Chu Juehai / Country: Mainland China
Publisher:
Publish Date: 2006-07-01
Features: In 2005, copper prices in the international market experienced significant fluctuations, which sparked discussions among domestic futures professionals and economists regarding a series of topics, including the functions of the futures market, institutional design, development paths, regulatory methods, risk management, and trading models. During these discussions, it was widely agreed that commodity futures possess two attributes: one is their commodity attribute, and the other is their financial attribute. Moreover, as the international futures market continues to develop, the financial attribute of commodity futures will become increasingly prominent.
The financial attribute of commodity futures originates from the inherent characteristics of the futures market. Standardized contracts, margin systems, and clearing mechanisms reveal the inherent financial nature of the futures market. The establishment of hedging mechanisms gives futures contracts capital securities characteristics, and the fulfillment of futures contracts through delivery also exhibits certain features of commercial paper. Trading limits, forced liquidation systems, and the daily settlement system, combined with margin requirements, form a credit system that enables effective monetary flow in the futures market. With such a credit system and the function of promoting monetary flow, the futures market acquires the fundamental attributes or characteristics of a financial market.
Hedging is a trading activity that can be settled by hedging and liquidation. The hedger achieves what is essentially two processes: hedging and liquidation in the futures market and spot trading in the spot market. Therefore, hedging transactions also reflect the financial attribute of commodity futures.
The emphasis on the attributes of commodity futures, particularly their financial attribute, reflects the gradual refinement of people's understanding of the functions of the futures market and also reflects the final positioning of its core function. Unlike traditional spot markets, where the core function lies in efficiently allocating limited resources through prices to enhance and maximize overall social welfare, the core function of the futures market lies in efficiently allocating risk through futures prices. By transferring risk from individuals with lower risk tolerance to those with higher risk tolerance, the futures market promotes the allocation of resources in its corresponding spot market. This is also the function of the entire derivatives market.
Forward contracts, futures, options, and swaps are the four fundamental instruments of the derivatives market and indispensable components of the market. On an international scale, futures and options, along with foreign exchange, stocks, bonds, and gold markets, have collectively formed a vast and comprehensive capital market system. In this system, no market can operate in isolation from the others. China's futures market has only a history of about 15 years, and options and swaps have not yet been launched. The risk management and control system is also underdeveloped. Therefore, we believe that efforts to develop the futures market and promote the development of other derivatives are essentially aimed at improving the entire risk allocation system. A domestic futures market lacking options and swaps will clearly suffer significant inefficiencies in risk allocation. From another perspective, if the goal is simply to use futures to hedge risk, the effect will not be very significant, as a modern, comprehensive risk-hedging system should include futures, options, and swaps in the derivatives market. A well-rounded hedging strategy should not merely...