Investment in Futures (Theory and Practice)

Author: Zhu Guohua, Chu Juehai
Publisher:
Publish Date: 2006-07-01
Features: In 2005, copper prices in the international market experienced significant fluctuations, sparking discussions among domestic futures professionals and economists regarding the functions, institutional settings, development paths, regulatory methods, risk management, and trading models of the futures market. During these discussions, it was widely agreed that commodity futures possess two attributes: one is the commodity attribute, and the other is the 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, while the fulfillment of futures contracts through delivery also exhibits certain features of commercial bills. Trading limits, forced liquidation rules, and the daily settlement system, combined with the margin system, form a credit system that enables effective monetary circulation in the futures market. With such a credit system and the function of promoting monetary circulation, 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 the futures market does in hedging and liquidation and what the spot market does in spot trading, making hedging transactions an embodiment of 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, the core function of spot markets lies in efficiently allocating limited resources through prices to enhance and maximize overall social welfare. In contrast, the core function of the futures market lies in efficiently allocating risks through futures prices, transferring risks from individuals with lower risk tolerance to those with higher risk tolerance, thereby promoting the allocation of resources in corresponding spot markets. This is also the function of the entire derivatives market.
Forward contracts, futures, options, and swaps are the four fundamental tools of the derivatives market and indispensable components of the derivatives 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 15-year history, and options and swaps have yet to be launched. The risk management and control system is not. 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 risks, the effect will not be very significant, as a complete risk hedging system in modern times should include futures, options, and swaps in the derivatives market. A comprehensive risk hedging strategy should not be limited to...