Question

Explanation Questions for FUTURES trading 1. Define open interest. Under what circumstance would a trade increase, decrease or leave open interest 3 What role does a clearing house play? How does a clearing house manage its risks? unchanged? 2. What is basis and what does basis tell us?

Answer 1

Open Interest and its various situtations i.e. Increase, Decrease and No change

Open interest can be defined as the number of contracts open or remain in the market that has not been settled or delivered. Open Interest in future maket plays a vital role which gives an information i.e. the liquidity of the market. if open interest is high then a bidder can go for better bid/ ask price.

Open interest incraeses when new contract entered into the market example: Sunil and Grover two participants eneterd into the market where sunil buys 6 contracts and Grower sales 6 contarcts. It means Sunil is in long position while Grower is in short. Open interest i.e. 6 contracts

Open interest decreases when some or few contracts are squarred up. example say Sunil becomes short of 2 contracts and Grower becomes long of 2 contracts then the Open interest is now became 4.

The instance when there is no change in open interest is that when Grower becomes short of 1 contract and another trader i.e. Anil comes to 1 long position. Here the Open Interest remains the same. In this case there is no change because the contract is changing hands i.e. from one investor to another. But the outstanding contracts are still same in numbers.

Basis and its implications:

?Basis tells the relationship between cash prices and future prices. It reveals the difference between cash and future prices. Positive basis is when cash prices are higher than future prices where down basis is when future prices are higher than cash prices. Increase in basis reveals that demand is higher than supply where contraction in basis reveals excess supply but relatively demand is low, in such situation future prices are higher than cash prices.

Role of Clearing House and how they mitigate risk:

Clearing house act as an intermediary between buyer and seller. Clearing house as an financial intermediary responsible for all settlements of contracts effectively. The various resposibilites comes under are:

Market Monitoring, Margin Monitoring, Mart to Market calculations, clearing and Settlements

In future contracts clearing house plays a crucial role, as future always involves risk and uncertainity. The unceratinity is managed by clearing house by providing a service that arrives when their is any counter party default risk has been arises. Clearing house is providing proper protection against counter party risk.

Margin trading is an wonderful mechanism using by the clearence house in order to mitigate risk.