A standardised futures or options contract traded on an organised exchange, with a clearing house as counterparty to every trade and daily margin settlement.
Standardisation concentrates liquidity. Because every contract for a given month is identical, buyers and sellers meet in one order book, spreads narrow, and a position can be closed by trading the opposite way rather than by unwinding a bilateral agreement.
Novation to a clearing house replaces bilateral credit exposure with exposure to the central-counterparty, backed by margin, a default fund and the clearing members. Daily variation-margin prevents losses accumulating unsettled.
The trade-off is fit: contract sizes, expiries and underlyings are fixed, so a hedge is usually approximate. Basis risk between the listed contract and the actual exposure is the price of the liquidity and credit protection.
Original diagrams for the ideas on this page. Illustrative, not real market data.
The bid-ask spread. Buy orders sit below, sell orders above, and the gap between the best bid (50.01) and best ask (50.04) is the spread you pay to cross. Bar length shows the size resting at each price.Margin and leverage. A $5,000 deposit can control a $100,000 position, which is 20:1 leverage. Because the loss is measured on the full $100,000, a 2.5% move against you halves the deposit and brings a margin call, and a 5% move uses all of it.
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