Post on 24-Apr-2022
Learning Guide
National Commodities Futures Examination
SerieS 3
v04
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 1
About the Series 3 Exam
Part 1 – Futures Trading Theory and Basic Functions Terminology Chapters # of Questions
General Theory 1, 3, 7, 9 and 11 16 (13% of exam)
Futures Margins, Options Premiums, Price Limits, Futures Settlements, Delivery, Exercise, and Assignment 1, 4, 6 and 11 15 (13% of exam)
Types of Orders, Customer Accounts, Price Analysis 3, 4 and 5 11 (9% of exam)
Basic Hedging, Basis Calculations, Hedging Futures 9 and 10 19 (16% of exam)
Spreading 8 3 (3% of exam)
Speculating in Futures 3, 4, 7 and 10 16 (13% of exam)
Option Hedging, Speculating, Spreading 11 5 (4% of exam)
Part 2 – U.S. Regulations Chapter # of Questions
Regulations 2 35 (29% of exam)
© Copyright 2021. All Rights Reserved. v04 The following presentation is owned by Securities Training Corporation and is protected by the United States Copyright Law and applicable international, federal, state, and local laws and treaties. The presentation is made available to you for your personal, non-commercial use as a study tool to assist you in preparing for the related examination and no other purpose. ALL OTHER RIGHTS ARE EXPRESSLY RESERVED. Any other use by you, including but not limited to, the reproduction, distribution, transmission or sharing of all or any portion of the presentation, without the prior written permission of Securities Training Corporation in each instance, is strictly prohibited.
1
120 True/False and Multiple-
Choice Questions
Two Hours and 30 Minutes Allotted to
Complete Exam
2
Minimum Required
Passing Score on Each Part
is 70%
4 30-, 30-, 180-Day
Waiting Period for Failures
5 5 Additional
Questions are Included as
Experimental (don’t count for
or against the score)
3
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 2
How to Begin
My.STCUSA.com Exam Center
Learning Tool 6 Final Examinations 125-question comprehensive exams Show Explanations button may be
turned ON or OFF Final Exams can be taken 8 times
each “My Scores” shows Diagnostics by
Chapter Create a Custom Exam feature An unlimited number of Custom
Exams can be taken
Evaluation Tools 3 A/B Progress Exams (6 total) Each 20-question exam covers
certain chapters Explanations provided upon
completion Progress Exams can only be taken
one time 2 Greenlight Exams 125-question comprehensive exams
used to gauge readiness Explanations provided upon
completion Greenlight Exams can only be taken
one time
View On-Demand Video for Chapter 1
Read Chapter 1 of Study Manual
Complete Flashcards for Chapter 1
Create 10-question Custom Exam for Chapter 1
Repeat these steps through Chapter 2, then complete your first Progress Exam
Continue this process until all chapters and Progress Exams have been completed
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 3
Chapter 1 – Commodity Futures
Futures Contract Evolved from forward contracts Like a forward contract, both parties to a futures contract have obligations
BUYER SELLER
Also called a long position Obligation to take delivery at expiration Also called a short position
Obligation to make delivery at expiration
Futures and Forwards A contract between a buyer and seller who agree to trade a specific commodity or asset at a later date (i.e., in the future)
Futures Forwards
A standardized quantity A variable quantity (as agreed)
Delivery at location and time specified by exchange rules
(i.e., regular for delivery warehouse) OTC-traded with negotiable terms
Non-personal Personal
Can be offset Cannot be offset If assigned, some exchanges force acceptance, which is referred to as being “stopped;” others allow closing trades
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 4
Activity #1 – Futures Contract An investor sold a wheat futures contract at $5.16 per bushel. At the end of the contract, if the price of wheat has fallen to $4.10 per bushel, which of the following statements is TRUE? a. The investor makes delivery. b. The investor takes delivery. c. The contract expires worthless. d. The investor neither makes nor takes delivery.
Futures Exchanges Exchanges will: Provide a place to trade Set contract terms which must be approved by CFTC
– Delivery size – Basis grades, which may allow for delivery of superior grade (for a premium) or inferior
grade (at a discount) – Time of delivery – Place of delivery - approved locations are referred to as “regular for delivery
warehouses” – Margin requirements – both initial and variation
Exchanges will not: Own any contracts Buy or sell contracts Set prices of contracts
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 5
CME Globex and Intercontinental Exchange (ICE) Both manage exchanges that provide a platform for investors to buy and sell futures (and other securities) on an international basis Contracts are fungible on an exchange of the same group (e.g., buy gold ICE futures U.S. and sell gold ICE futures Europe)
CME Group ICE
Exchanges include: Chicago Mercantile Exchange (CME) Chicago Board of Trade (CBOT) Minneapolis Grain Exchange (MGEX) Commodities Exchange (COMEX) New York Mercantile Exchange (NYMEX) Partnerships with exchanges in Brazil,
Malaysia, Dubai, Korea and CME Europe Ltd.
Retail and institutional investors have access to the same prices CME Clearing guarantees all contracts that are traded on the CME Globex platform
Exchanges include: ICE Futures U.S. (IFUS) ICE Futures Europe (IFEU) ICE Futures Singapore (IFSG) ICE Endex (NDEX)
Retail and institutional investors have access to the same prices Clearing is done by ICE Clear U.S., ICE Clear Europe, and ICE Clear Singapore
Benefits of Futures Exchanges Allows producers and users of the cash commodity to hedge by establishing a futures position that’s opposite the cash position Substantially reduces risk of price fluctuations Enables producers and users to obtain credit at more favorable rates Reduces the price of the commodity to the public
Provides a central point to channel risk capital of speculators Increases liquidity and narrows price spreads
Provides a focal point to where all buy and sell orders are sent Price discovery
Price dissemination Provides an alternate channel for marketing the cash commodity
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 6
Exchange Committees Arbitration Committee that settles disputes which arise between members,
member firms, and the public
Business Conduct Committee that investigates complaints against members, acts to prevent price manipulation, and supervises members and their employees
Floor Committee that establishes rules regarding trading on the floor of the exchange and settles disputes related to transactions on the floor
Traders and Trading
Types of Traders
Floor Brokers Execute orders on behalf of others Work for firms or independent
Floor Traders (Locals) Trade for their own account May also trade for a firm’s proprietary account Cannot take customer orders
Types of Trading
Day Trading Trade and offset the same day
Position Trading Establish longer open positions
The Clearinghouse The clearinghouse is an agency that’s associated with an exchange which guarantees all trades, thereby assuring contract delivery and/or financial settlement Since the clearinghouse becomes the buyer for every seller and the seller for every buyer, it eliminates counter-party risk Exchange members collect and deposit funds (i.e., margin) with the appropriate clearinghouse
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 7
Activity #2 Read each statement and determine whether it’s TRUE or FALSE.
FUTURES CONTRACTS MAY BE MODIFIED TO FIT A SPECIFIC HEDGER’S NEEDS
DELIVERY OF A SUPERIOR GRADE OF A COMMODITY WILL GIVE
THE SELLER A PREMIUM PRICE
THE FLOOR COMMITTEE IS CONCERNED WITH PREVENTING SIDE AGREEMENTS
BETWEEN FLOOR BROKERS
THE BUYER DETERMINES WHICH GRADE WILL BE DELIVERED
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 8
Chapter 2 – Regulations
Regulatory / Supervision Overview NFA Members Futures Commission Merchant (FCM)
Introducing Broker (IB) Commodity Pool Operator (CPO)
Commodity Trading Advisor (CTA)
The CFTC Objectives of the CFTC: Prevent manipulation Prohibit the spread of false or misleading information Establish ethical trading standards Approve new futures and options contract specifications Regulate exchanges and floor members Provide for settlement of customer claims CFTC and NFA employees cannot trade futures
CFTC
National Futures Association
(NFA)
Futures Exchanges
Associated Persons
The Commodity Futures Trading Commission is a federal agency that was created in 1975
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 9
CFTC Delegation The CFTC delegates some of its authority to:
NFA Exchanges Clearinghouses
The NFA is a self-regulatory agency of the futures industry
Carry out CFTC-delegated responsibilities
Handle trading activities of contract markets
Activities are subject to CFTC review
Agency associated with an exchange that guarantees trades
Becomes the buyer for all sellers and the seller for all buyers
Eliminates counter-party risk
CFTC Disciplinary Actions The CFTC: Maintains disciplinary jurisdiction over floor brokers, traders, and exchanges Is empowered to go directly to the courts to seek a restraining order
(independent of the U.S. Attorney General)
Penalties and Actions: Felony Convictions for Criminal Violations of the Commodity Exchange Act:
Suspension or revocation of CFTC registration
Maximum civil monetary penalty is the greater of $168,142 per violation (indexed for inflation, originally $140,000), or three times the damages (non-felony)
Suspension or revocation of trading privileges
Settlement may be achieved without admitting or denying charges, with penalties carried as if they were applied following a hearing
Suspension or expulsion Fines of up to $1 million ($500,000 for
individuals) and/or 10 years imprisonment
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 10
Reporting Levels and Position Limits Established by CFTC and enforced by the Exchanges
Reporting Levels
CFTC requires daily reports of gross long or short positions in each commodity once it reaches a certain threshold level
FCM that carries position must also report One last report is filed on the day the account falls below threshold Applies to both hedgers and speculators
Position and Trading Limits
Designed to prevent manipulation and distortion of prices Applies to only certain commodities Applies to only speculators Bona fide hedgers are exempted
Market Participants FCM Futures Commission Merchant
A large futures firm (B/D) that handles customer accounts
IB Introducing Broker A small futures firm (most online firms) that introduces and solicits
clients for associated FCMs
CPO Commodity Pool Operators Operates and solicits funds for a commodity pool
CTA Commodity Trading Advisor Advises others in trading futures May work for an IB, FCM, CPO, or advise individual accounts for a fee
Associated Person (AP) An AP is an individual who conducts the business of FCMs, IBs, CTAs, and CPOs Includes officers, partners, employees, solicitors, supervisors
Any person who’s required to register with the CFTC must be an associate member of the NFA Qualifications Series 3 Series 31 (for commodity pools only) Series 30 (for managers)
An AP may have multiple registrations with approval of all firms
Typically, prospective customers will discuss their financial goals with an associated person and
the AP will explain the risks involved in futures trading.
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 11
Activity #3 Match each description to the appropriate term.
FCM A natural person that conducts the business
of an NFA member
IB Manages a pool of investments in commodity
futures or options
CTA Advises others on the purchase or sale of
commodity futures or options
CPO
Solicits and/or accepts orders for execution
Associated Person Solicits and/or accepts order for execution,
but cannot accept customer funds
National Futures Association (NFA) The NFA is a self-regulatory agency of the futures industry that’s responsible for: Enforcing ethical standards Providing for arbitration of disputes Ensuring minimum financial standards Screening registrations Establishing training standards and proficiency testing Auditing members (spot and full scope)
– Unannounced spot audits – Full scope audit every 24 months (no need for court approval to subpoena documents) – NFA members are required to audit their branches at least annually
Ethics training – Firms must have a written policy – Must demonstrate compliance upon audit
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 12
NFA Registration All market participants are required to register with NFA Exemptions from registration: Floor traders and brokers (subject to Exchange rules) Some CTAs and CPOs may also be exempt under specific circumstances (discussed later) Exchange members that are registered with CFTC (not with NFA) and are subject to fines
by the CFTC If any NFA member is required to notify the CFTC on any matter, it must also be reported to the NFA NFA members cannot conduct business with non-member firms
Futures Commission Merchant (FCM) May hold customer accounts and assets Must maintain minimum net capital of $1 million May be a clearing or non-clearing firm (may be a clearing firm on some exchanges, but a
non-clearing firm on others) – Clearing FCMs are members of the clearing corporation that process and clear their
own trades which are executed on an exchange – Non-Clearing FCMs process their trades through clearing firms
Trades are cleared through either an omnibus account or fully disclosed account Omnibus: Only discloses
the name of the non-clearing FCM
Fully Disclosed: Discloses the client’s information to the Clearing FCM
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 13
Introducing Broker (IB) An IB: Must have an affiliation with an FCM Does NOT hold customer accounts or assets Is not required to maintain a copy of customer statements
Two types:
Independent IB Able to find clients for any FCM Has a minimum required net capital of $45,000
Guaranteed IB
May be guaranteed by only one FCM FCM with which it has an agreement is responsible for GIB’s
activities – The agreement has no expiration
FCM is required to audit its GIB at least annually Has no minimum required net capital
(i.e., the FCM satisfies the $45,000) Need not be exclusive
Commodity Pool Operator (CPO) Pools funds of several investors to trade as one account Funds are accepted in the name of the pool Customers are percentage owners in the pool
(similar to a limited partnership) CPO must run each pool as a separated entity CPO must maintain daily transaction records for the pool All withdrawals from a commodity pool must be properly disclosed to all participants
Essentially, an IB is a firm that solicits or accepts orders to buy or sell futures contracts, but doesn’t accept money.
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 14
CPO Registration Exemptions Pool operator is the NFA member May solicit one or more pools Required to register unless exempt
CPO Exemptions from Registration
De Minimis Commodities Investment Club
Gross contributions to all pools is less than $400,000 and
There are no more than 15 participants in any one pool (excluding the CPO and his family members)
Operates only one pool at a time Receives no compensation other than
operating expenses Doesn’t advertise
CPO Account Statements CPOs must send account statements to all participants Statement of Income/Loss Monthly – if pool is more than $500,000 Quarterly – if pool is less than or equal to $500,000
An exempt CPO must file a statement with NFA to indicate the reasons for its exemption and a copy must be sent to all participants
Generally Accepted Accounting Principles (GAAP) must be used
It must show changes of NAV and reflect all fees (net of fees)
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 15
Commodity Trading Advisor (CTA)
CTA Registration Exemptions A CTA is required to register with the NFA unless: It’s registered as a CPO and only advises its own pool
– If it provides advice to other pools, it must register as CTA It advised no more than 15 persons within the last 12 months, and it doesn’t publicly hold
itself out as an advisor It’s a publisher (newspapers and magazines) It’s a non-profit, voluntary membership organization (e.g., investment club), or a trade
association
CTA/CPO Disclosure Document Similar to a securities prospectus A copy must be filed with the NFA at least 21 days prior to its first use The front cover must indicate: Effective date – not earlier than 21 days after filing
– Information must be current (not older than three months) – May be used for 12 months from this date
Whether up-front fees apply; if so, net proceeds available “No approval clause;” also referred to as the “cautionary statement”
– CFTC has neither passed on the merit of this investment, nor has it passed on the adequacy or accuracy of this disclosure document
Managed Accounts If a CTA handles managed accounts, it must be carried on a fully disclosed basis
by the FCM FCM (not the CTA) is responsible for sending account statements to clients
A CTA is any person who: Engages in the business of advising others as to buying or selling commodity
futures or options contracts Provides this service for compensation or profit
CTA cannot accept customer funds directly (only through FCM)
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 16
Risk Disclosure Document The following must be reflected on the first page of the disclosure document High leverage Magnified risk and potential return – volatility,
liquidity, counter-party credit risk May be subject to substantial charges, with details of
the charges (e.g., management, advisory, and broker fees)
Other information within the document: Types of futures and options that will be traded Minimum and maximum size of the pool (if any) All applicable fees (up front and annual fees) How the fund meets the margin call Breakeven analysis Five-year business background of CPO and CTA
trading principals All civil and criminal actions (by CFTC, NFA, and clients) for five years
Risk Disclosure Document Actual and potential conflicts of interests must be disclosed Whether the CPO also operates as a CTA Whether the CPO (or an affiliate) receives a portion of the commissions The names of IB and FCM, if the customer is required to trade through them Whether the pool invests only in foreign futures and still needs to be registered
Risk Disclosure Document Performance history must be disclosed by the CPO: Monthly rates of return must be displayed in either tabular form or by bar graph The number of outstanding units must be included at the beginning and the end of the
period for which performance is included – If history is more than five years – show the last five years – If history is between three and five years – show the entire history – If history is less than three years – show the entire history plus:
• Lesser of five years or the entire history of any other pool operated by the CPO or CTA
Checklist of Information Included in Risk Disclosure Document
Business background CTA trading program and
pool investment program Principal risk factors Fees Conflicts of interest Litigation Performance
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 17
Activity #4 Determine the performance history disclosure requirement for each CPO.
CPO MANAGED ONE POOL FOR THE LAST SIX YEARS
CPO MANAGED ONE POOL FOR THE LAST FOUR YEARS
CPO MANAGED ONE POOL FOR THE LAST TWO YEARS
CPO MANAGED TWO POOLS: NEW POOL: FOR LAST YEAR OLD POOL: FOR LAST 10 YEARS
Some Prominent Rules of the NFA NFA Rule 2-4: Members and associates must observe high standards of commercial honor
and just and equitable principles of trade in the conduct of their commodity futures business NFA Rule 2-38: All members must establish and maintain a written business continuity and
disaster recovery plan, which indicates the name and contact information for one or two individuals who are to be reached by the NFA in case of an emergency
NFA No Approval Clause: The CFTC and NFA don’t sponsor, approve, or recommend an AP Foreign brokers who work in U.S. branch offices overseas must be properly registered
(Series 3 qualified)
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 18
NFA Compliance and Disciplinary Actions Infractions are reported to the Regional NFA Business Conduct Committee The NFA Compliance Director can: Require statements under oath from members Subpoena documents
While under investigation, a member may not resign, but may continue to do business With agreement of the board, the President of the NFA can initiate a “Member Responsibility Action” Firm may be required to immediately cease doing business Doesn’t require a hearing beforehand
NFA Compliance and Disciplinary Actions Disciplinary Actions:
Original jurisdiction is given to the Hearing Panel which may decide on: Suspension or revocation of NFA membership Barring from association with NFA member firms Censure or reprimand Fine of up to $250,000 per violation (non-felony) Issuance of cease and desist order NOT prison
Formal rules of evidence need not apply
Appeals Process:
Appeals committee of the NFA CFTC Federal courts
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 19
Arbitration Used for the settlement of disputes between member firms, or member firm and customers Must be filed within two years of discovery Decisions cannot be appealed
Disputes of up to $50,000 Disputes of over $250,000 Judgments and Awards
Normally handled by one arbitrator
Respondent must respond within 20 days of complaint
Normally handled by three arbitrators
Defendant must respond within 45 days
Judgments must be rendered within 30 days of closing of records
Awards must be paid within 30 days of judgment, or the respondent will be subject to suspension
Communication With the Public Written communications with the public and all promotional material (including the text of standardized oral presentations) require prior approval of a partner or officer of the firm Copies of all promotional material, along with their approvals, must be maintained for five years NFA prohibitions: False or misleading statements or omissions of material facts Emphasizing profits without giving equal weight to risks Citing past profits without cautioning that they may not represent future profits Using statistics which cannot be substantiated Using hypothetical performance without providing a special disclosure statement
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 20
Activity #5 Read each statement and fill in the blanks. 1. _____________________ is the maximum fine for violations of the Commodity Exchange Act. 2. The CTFC can assess a civil penalty of ______________________ per violation or
__________ times the damages. 3. The NFA will provide ___________ arbitrators for disputes exceeding ________________. 4. The maximum fine the NFA can assess is ______________ per violation. 5. Violations of _____________________ cannot be punished with a prison sentence. 6. A criminal violation of the _____________________________________ can result in a
______ year prison sentence. 7. Disputes of up to ______________ will be handled by __________ arbitrator(s).
Opening Customer Accounts Must be signed by all parties before trading
AP is responsible for getting this document signed and dated at or prior to account opening A copy is retained by all parties involved (IB, FCM)
Name and address Legal age (age of majority) Principal occupation
Estimated annual income and net worth Investment and futures trading experience
Information is not required to be verified (customer can by the only source of information)
1. Fill out Commodity Account Agreement
4. Account approval by a principal
2. Read and sign Risk Disclosure Document
3. Information needed (NFA Rule 2-30 “Know Your Customer”)
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 21
Risk Disclosure Proper Disclosure: For some customers, the best disclosure statement may be that trading futures is too risky
for them Spread positions should not be described as having less risk
– Created by purchasing one futures contract and selling another Additional Risk Disclosures: AP must determine whether they’re needed Option Disclosure Document is needed to open an option account (cannot be opened without
a future account)
Customer Account Documentation If customer refuses to disclose information, the necessary step is based on the type of customer: If customer is a U.S. citizen – A record of the refusal must be maintained If customer is a non-U.S. citizen – No record of the refusal needs to be maintained
Margin Agreement must be signed by all clients For commodities, there’s no cash account
Transfer Agreement or (“Supplementary Agreement”) Allows FCM to transfer monies to/from client’s securities account If no such agreement was signed, FCM must obtain the client’s specific, written approval for
each transfer
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 22
Types of Accounts Individual One owner on the account
Joint
Multiple owners; information must be obtained from all owners Joint Tenants With Rights of Survivorship (JTWROS)
‒ Typically spouses ‒ Account passes whole without probate
Tenancy In Common (TEN-COM) ‒ Typically business partners ‒ Account divided on death
Corporate Firms must obtain: Copy of charter and by-laws which allow for futures trading Resolution authorizing an individual(s) to act on the corporation’s
behalf
Partnership Copy of the Partnership Agreement must be obtained
Trust Copy of the Trust Agreement must be obtained
Discretionary Account If an AP is given discretion over an account Requires written power of attorney (PoA) All trades are reviewed by a principal within one business day AP must have two years’ experience (unless a CTA) PoA doesn’t need to be renewed, but will become void upon the customer’s death
If a third-party is given discretion over an account (i.e., a person other than an AP) Actual customer must give permission Duplicate confirmations must be sent to the customer
Review for churning: Excessive trading in the account to generate commission
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 23
Activity #6 – Discretionary Account A discretionary account may be handled by: a. An associated person who’s registered with the NFA b. An associated person with one year’s experience c. An associated person who was previously registered for one year and six months and has
been registered with your firm for six months d. An associated person with four years’ experience
Recordkeeping Customer Account Statement – must be sent by FCM For active accounts (at least one transaction or an open position) – sent monthly For inactive accounts – sent at least quarterly
Customer Confirmations – must be sent by no later than the next business day Customer Complaints (not public record) – firms are required to maintain a copy of all written complaints If an oral option complaint is received, firms must request that it be made in writing and must
maintain a copy Settlements (public records) – can be reached between firms and customers or regulators without admitting or denying guilt
NFA members are generally required to maintain records for five years
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 24
Recordkeeping
If the customer is introduced by the IB to the FCM: Account form must be kept on file by both
the IB and FCM FCM’s customer statement must
show the name of the IB
CTA records: Powers of attorney List of all positions Copies of each confirmation
and statement from FCM All communication with the
public (advertising and sales literature)
CPOs, CTAs, and their principals: Must maintain detailed daily record of all
personal transactions and all statements received from the FCM
Upon death of a customer: Powers of attorney is
automatically canceled Cancel all open (GTC) orders Liquidate all positions
The USA PATRIOT Act Currency Transaction Reports (CTR) Currency and Monetary
Instrument Transaction Report (CMIR)
Filed for all currency transactions executed by a single customer during one business day that exceed $10,000
Filed also for structured transactions
Filed whenever a person physically transports or receives cash (or equivalents) exceeding $10,000 into, or out of, the U.S.
Suspicious Activity Report (SARs) Penalties
Filed whenever a transaction (or group of transactions) equals or exceeds $5,000 and the firm suspects the transaction is designed to evade reporting requirements or has no apparent business purpose
Confidential (client not informed)
20 years in prison and the greater of a $500,000 fine per transaction or twice the amount of funds involved
Necessary Records
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 25
Chapter 3 – Price Forecasting
Relationship Between Cash and Futures Since futures contracts are either physically delivered or settled based on cash commodity prices, there’s a strong relationship between cash and futures prices Prices between the two must converge Prices must converge on the first day delivery If prices don’t converge, an arbitrage opportunity will
exist – As a result of arbitrage activity, prices will then
converge
Carrying Charges
Transportation expenses are not included in carrying charges
Carrying Charge
Storage Insurance Interest
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 26
Activity #7 – Carrying Charge Cash corn is trading at 600 cents per bushel. Storage costs are 4 cents per bushel, insurance expenses are 2 cents per bushel, and shipping costs are 45 cents per bushel. If monthly interest rates are 1%, what’s the monthly carrying charge?
Carrying Charge Market
Cash Price:
Interest Rate:
Interest Expense:
Storage:
Insurance:
Total Storage:
Total Carry Charge:
$1,755
$1,760
$1,765
$1,770
$1,775
$1,780
$1,785
$1,790
$1,795
$1,800
$1,805
Cash Aug Oct Dec
Contango, Normal, or Premium Market(Gold futures)
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 27
Inverted Market
Activity #8 Determine whether the following statements are TRUE or FALSE.
1 Carrying charges include storage, interest, insurance and transportation.
2 A normal market is one in which cash prices are above futures prices.
3 An inverted market is one in which cash prices are above futures prices.
4 In a normal market, the price of a cash commodity is under futures prices.
5 A contango market is one in which futures are higher than cash.
6 Backwardation is a market in which futures are higher than cash
7 Cash and futures prices will converge on the first delivery date.
$1,725$1,730$1,735$1,740$1,745$1,750$1,755$1,760$1,765$1,770$1,775
Cash Aug Oct Dec
Backwardation or Discount Market(Gold futures)
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 28
Fundamental Analysis Fundamental analysis focuses on the relationship between a commodity available for delivery and the price For grains, the supply typically includes stocks in elevators, in transit (e.g., on barges), and on docks at loading centers. However, the supply excludes grains still on farms.
Technical Analysis Volume and
Open Interest Support and
Resistance Levels Charts and
Price Patterns
Volume Total trades during a
day • Count either
purchases or sales, not both
• Sign of activity or liquidity in the market
Open Interest All open contracts that
have not been offset • Count either all
outstanding long or short positions, not both
Support Level at which prices stop
falling A temporary price floor
Resistance: Level at which prices stop
rising A temporary price ceiling
Technical Patterns Double bottom or top Head and shoulders Ascending or descending
triangle Moving average Flag and pennant
Price
Quantity
Demand
Supply
Supply – When supply increases, the price decreases
Demand – When demand increases, the price increases
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 29
Volume and Open Interest First Trade: FCM A buys 10 contracts from FCM B
Accumulated Volume: Open Interest:
Second Trade: FCM B buys 10 contracts from FCM C
Accumulated Volume: Open Interest:
Third Trade: FCM C buys 10 contracts from FCM A
Accumulated Volume: Open Interest:
FCM A FCM B FCM C LONG SHORT LONG SHORT LONG SHORT
Open Interest and Prices
Price Open Interest
Price Open Interest
Technically Strong Bullish Trend Technically Strong Bearish Trend
Price Open Interest
Price Open Interest
Technically WEAK Technically WEAK
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 30
Activity #9 – Liquidating Market A liquidating market is: a. When prices and open interest are both rising b. When prices are rising and open interest is falling c. When prices and open interest are both falling d. When open interest is rising and prices are falling
Technical Analysis Support Level at which prices tend to stop falling
Resistance Level at which prices tend to stop rising
Congestion Area Area between support and resistance; prices trapped in a range
Breakout When prices break through an area of support or resistance Breakout of an area of support is a bearish indicator Breakout of an area of resistance is a bullish indicator
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 31
Resistance/Support Levels A breakout above resistance is bullish, a breakout below support is bearish
1. To take advantage of a potential breakout of support, what order could be entered?
A. Sell Limit above support C. Sell Stop below support
B. Buy Stop above resistance D. Market order 2. To take advantage of a potential breakout of resistance, what order could be entered?
A. Buy Limit above support C. Sell Stop below support
B. Buy Stop above resistance D. Market order
Congestion
81.50
79.70
Resistance
Support
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 32
Head and Shoulders Patterns
Activity #10 Determine whether each indicator is BULLISH or BEARISH.
A BREAKOUT OF RESISTANCE
A BREAKOUT OF SUPPORT
HEAD AND SHOULDERS TOP
HEAD AND SHOULDERS BOTTOM
Head and Shoulders Top
Reversal of an __________________ trend
Bearish indicator
Head and Shoulders Bottom
Reversal of a __________________ trend
Bullish indicator
Head (Top)
Right Shoulder Left
Shoulder
Right Shoulder
Left Shoulder
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 33
Chapter 4 – Pricing
Contract Sizes Grains (Corn, Wheat,
and Soybeans) 5,000 bushels
Treasury Bonds and Treasury Notes
(Long-Term)
$100,000 par value Quoted as percentage of par and 1/32 1% of $100,000 is $1,000 and 1/32 of $1,000 is $31.25
Treasury Bills and Eurodollars
(Short-Term)
$1,000,000 par value 13-week (3 months) Quoted in basis points; 100 bps = 1%
• 1 basis point equals $25
Bond Calculations Adding Fractions Subtracting Fractions
90 25/32 + 6 30/32 96 55/32
96 55/32
[96 + 1] [55/32 – 32/32]
90 25/32 – 6 30/32 84 – 5/32
90 25/32
[90 – 1] [25/32 + 32/32] 89 57/32
89 57/32 – 6 30/32
97 23/32
83 27/32
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 34
Bond Price Analysis
Currency Price Analysis
Bond Prices
$ Market Interest Rates
$
INVERSE RELATIONSHIP
As market interest rates change, a bond’s price will change in the opposite direction. They have an inverse relationship.
$ €, £, ¥ or Gold
INVERSE RELATIONSHIP
The U.S. dollar has an inverse relationship with foreign currencies. Gold can also be a substitute for foreign currencies; it will also move in the opposite direction of the U.S. dollar.
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 35
Price Limits The board of directors of an exchange will establish daily price limits for futures prices When the market reaches the upper or lower limit, trading will continue within the limits Buy and sell orders can be entered above or below the limits, but they cannot be executed Typically, the nearest expiration month and cash price don’t have any price restrictions
Activity #11 – Price Limits If futures trade at the daily limit: a. All buy and sell orders are immediately canceled b. Trading at prices in-between the limits could still occur c. Offsetting transactions are permitted, but no new positions maybe established d. Trading halts for the remainder of the day
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 36
Chapter 5 – Orders
Market Order Limit Order Customer wants to buy or sell Order is immediately executed at the
best price available Customer specifies the futures and
size of the order only Execution is ______________
Customer only wants to buy or sell at a set price or better
Order is only executed if the price can be met
Buy limits: at set price or lower Sell limits: at set price or higher
Customer specifies the futures, size, and price
Execution is ______________
Stop Orders Stop Orders are a type of contingent order which are “triggered” (activated) by the market trading at or through the stop price Sell Stop will activate with a trade or offer at or below the stop price Buy Stop will activate with a trade or bid at or above the stop price
Once activated:
A firm may accept orders that are activated at a different trigger price (using a quote as the stop price) provided they’re not labeled as stop orders and proper disclosures are made
Stop order becomes
Stop limit order becomes
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 37
Stop Order Example A customer is long November crude oil at $50.70. Today, crude oil opens at $46.25. Afraid of suffering large losses, your customer enters a protective order:
Sell November crude oil at $42.00 stop
Later: 42.10 42.06 42.03 41.98 41.97 41.91
Trigger? Execution?
If the customer entered a sell stop limit: Sell November crude oil at $42.00 stop
Later: 42.10 42.06 42.03 41.98 41.97 41.91
Trigger? Execution?
Market-If-Touched (MIT) Orders Entered on the same side of the market as limit orders, but activated or triggered like stop orders Sell MIT orders are placed above the market Sell MIT orders are activated when futures trade or bid at or above the MIT price Buy MIT orders are placed below the market Buy MIT orders are activated when futures trade or offered at or below the MIT price
Once activated, Market-If-Touched orders become market orders and are executed at the market price
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 38
Activity #12 – MIT Order Frank wants to take a long position in September Sugar futures if the price drops to 10.80 cents. Today, Sep Sugar opens at 10.90 Frank places the following order:
Buy Sep Sugar at 10.80 MIT
Later: 10.87 10.84 10.80 10.81 10.77 10.76
Trigger? Execution?
Order Placement
SL o BS
BL e SS
Types of Orders Type of Order Placed How Triggered How Executed
Market N/A N/A Best price Buy Limit Below Market N/A At or lower Sell Limit Above Market N/A At or higher Buy Stop Above Market Traded at, through, or bid at or above Best price Sell Stop Below Market Traded at, below, or offered at or below Best price
Buy Stop Limit Above Market Traded at, above, or bid at or above At or lower Sell Stop Limit Below Market Traded at, below, or offered at or below At or higher
Buy MIT Below Market Traded at, below, or offered at or below Best price Sell MIT Above Market Traded at, above, or bid at or above Best price
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 39
Activity #13 Determine whether each order is typically entered ABOVE or BELOW the current market price.
BUY LIMIT
SELL LIMIT
BUY STOP
SELL STOP LIMIT
BUY MIT
SELL MIT
Other Orders
Not Held (NH)
Broker is given discretion as to time and price Broker is given authority as to whether to take the position Broker cannot be held responsible for any action it takes or
fails to take
One Cancels Other (OCO)
Instructs the broker to do one of two alternative orders Whichever is done first automatically cancels the other Prevents a double fill
Other Orders Give Up
One FCM “gives up” orders to other FCMs to protect the client’s anonymity
FCMs share commissions
Switch Liquidate and roll the existing position to a later delivery month Primarily used by the speculators prior to the first notice day
Allocation of Bunched Orders
Doesn’t need to be specified by CTA at the time of order entry It must be done by the CTA or the account manager before the
end of the day Subject to fair, equitable, and non-preferential standards
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 40
Chapter 6 – Margin
Margin Margin is established by the exchange as a “good faith deposit” and is not part of the cost Bona fide hedger’s margin is lower than speculation margin Initial equity – requirement to establish a position Maintenance (Variation) margin – requirement to keep a position Equity is calculated daily based on the contract’s settlement value
Calculating Equity Total equity in a position is equal to the money deposited, net of withdrawals, and is referred to as the Account Cash Balance The Account Cash Balance plus or minus the gains or losses to date is referred to as the Open Trade Equity (OTE) The cash deposit is equal to the initial margin requirement plus any additional deposits for
variation margin The open trade equity is calculated daily based on the contract’s settlement price
Margin requirements are the same for long and
short positions
If equity falls below the maintenance level, the client’s required to bring equity back to initial margin
Total Equity = Account Cash Balance +/- Open Trade Equity
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 41
Equity Example Wheat futures contracts have an initial margin of $0.80 per bushel and maintenance margin of $0.60 per bushel. The contract size is 5,000 bushels. A customer goes long one May wheat contract when the price is $6.00 per bushel.
Deposit/Withdrawal Account Cash Balance OTE Equity
Initial Margin
May Wheat to $5.90
May Wheat to $5.75
Margin Call
May Wheat to $5.95
Equity Example Gold futures have an initial margin requirement of $70.00 per ounce, a maintenance requirement of $50.00 per ounce, and a contract size of 100 troy ounces. A customer shorts one December gold contract when the price is $1,400.00.
Deposit or Withdrawal Cash Balance OTE Equity
Initial Margin
Dec Gold to $1,425
Receive a margin call
Equity above the initial margin (i.e., excess) may be withdrawn. Excess equity can also be used for margin on new positions, which is referred to as “pyramiding.”
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 42
Activity #14 – Calculating Equity A client shorts five June S&P 500 futures at 1,305.5. The initial margin on S&P 500 futures is $25,000 per contract and it has a multiplier (i.e., size) of $250 per index point. If the June S&P 500 contract settles at 1,295.5, what’s the equity in the customer’s account? a. $27,500 b. $137,500 c. $22,500 d. $112,500
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 43
Chapter 7 – Speculation
Speculators Buy and sell for the purpose of making a profit and will take: A long position (buy futures) when they anticipate a rise in prices A short position (sell futures) when they anticipate a decline in prices
Speculators add liquidity and reduce price volatility to markets
Rate of Return An investor who is bullish on May wheat takes a long position when the price of the May wheat contract is $5.10. The contract size is 5,000 bushels. The investor later offsets when the price is $5.50. If round-turn commissions are $50 and initial margin is $0.50 per bushel, what’s the investor’s rate of return?
Sold: Bought: Profit: Contract size: Gross profit:
Commissions: Net profit:
Initial Margin: Rate of Return:
Commissions on futures trades are typically “round-turn,” which includes both a purchase and a sale
Half-turn commissions only include one transaction
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 44
Rate of Return A trader believes July corn futures will fall; therefore, he shorts three contracts at $6.75. The contract size is 5,000 bushels. When the price has risen to $7.05, the trader offsets the contracts. If round-turn commissions are $25 per contract and the initial margin $0.60 per bushel, what’s the trader’s rate of return?
Sold: Bought: Loss: Contract size: Gross loss:
Commissions: Net loss:
Initial Margin: Rate of Return:
Rate of Return November soybean futures are trading at 1260 cents per bushel. The contract size is 5,000 bushels and the initial margin requirement is $3,500 per contract. An investor establishes a long position in the November contract at the current price. Later, she liquidates her position when the November soybean futures have increased by 5%. What’s the investor’s rate of return?
Long Increase: Profit: Contract size: Gross profit:
Initial Margin: Rate of Return:
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 45
Profit or Loss An investor expects yields on T-bonds to rise and takes the appropriate position on 10 September T-bond futures at 88-24. Later, the investor offsets the contracts at 90-20. If round-turn commissions are $40, what’s the investor’s profit or loss?
Should the investor take a Long or Short position?
Short: Loss:
Offsets: Commissions:
Loss: Loss per contract:
No. of contracts:
Total Loss:
or
Profit or Loss Investor expects the interest rates to decline and takes the appropriate position in four T-bill contracts at 92.05. The investor later offsets three contracts at 93.04 and liquidates the last one at 93.14. What’s the total profit or loss for this investor?
Should the investor take a Long or Short position?
Long: Long:
Sell: Sell:
Profit: Profit:
Multiplier: Multiplier:
Profit per contract: Total Profit:
No. of contracts:
Profit:
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 46
Activity #15 – Speculation A client buys a May silver futures at $17.240. The initial margin on silver futures is $12,000 per contract and requires acceptance of 5,000 troy ounces. At what value does the May contract need to settle for the customer to realize a $5,000 profit? a. $1.000 b. $5,000 c. $16.240 d. $18.240
Activity #16 – Speculation A client sells a December corn futures at 319.25 cents. The initial margin on corn futures is $1,500 per contract and requires delivery of 5,000 bushels of corn. At what value does the December contract need to settle for the customer to realize a $3,500 profit? a. $0.70 b. $2.4925 c. $3.8925 d. $3.1995
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 47
Chapter 8 – Spreads
Commodity Spreads
Intramarket or Interdelivery Spreads
Purchase and sale of the same commodity, on the same exchange, but in different expiration months
Example: • Buy March wheat on CME and sell July wheat on CME
Intermarket Spreads
Purchase and sale of the same commodity on different exchanges Example:
• Buy gold on COMEX (U.S. delivery) and sell gold on ICE (U.K. delivery)
Intercommodity Spreads
Purchase and sale of different commodities Examples:
• Corn and wheat • Corn and oats • Gold and silver • T-notes over T-bonds
‒ Yield curve flattens: Short T-note futures and go long T-bond futures
‒ Yield curve steepens: Long T-note futures and short T-bond futures
Commodity Product Spreads
Hedgers or speculators take positions in raw commodities and opposite positions in the refined or processed commodity
The Crush Long soybeans → Short soybean oil and meal
The Crack Long crude oil → Short gasoline and heating oil
Reverse crush or crack spreads reverse the long and short positions
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 48
Bullish and Bearish Spreads Generally, the spreader’s market sentiment will be reflected in their position in the near month Bullish investors will buy the near month Bearish investors will sell the near month
However, foreign currencies and stock index futures spreads are exceptions When spreading those contracts, the sentiment will be reflected in the position in the deferred month Bullish investors will buy the deferred month Bearish investors will sell the deferred month
Spread Profit and Loss Spread trades get their name from the difference or “spread” between the prices of the two contracts bought and sold Traders that buy the more expensive leg will profit if the spread between the prices increases
or widens BUYER = WIDEN
Traders that sell the more expensive leg will profit if the spread between the prices decreases or narrows
SELLER = NARROW
Example: An investor shorts March corn at 319 cents and buys July corn at 323 cents
Bullish or Bearish? Bearish, since the investor sold the near month (March)
Widen or Narrow? Widen, since the investor bought the more expensive leg (323)
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 49
Spread – Example Sell January soybeans at 841 cents Buy May soybeans at 844 cents
(Soybean futures have a 5,000-bushel size)
Spread: 3 cents, or $0.03
Bullish or Bearish: Bearish, sold the near month (January)
Widen or Narrow: Widen, bought more expensive (844)
Later, the positions are offset when:
January soybeans are 840 cents May soybeans are 847 cents
Spread: 7 cents, or $0.07
Widened or Narrowed: Widened
Profit or Loss: Profit
Amount: $200 ($0.04 widening x 5,000 bu.)
Spread – Example Sell September E-mini S&P 500 at 2853.10 points Buy December E-mini S&P 500 at 2830.75 points
(E-mini S&P 500 futures have a $50 multiplier)
Spread: 22.35 points
Bullish or Bearish: Bullish, bought the deferred month (December)
Widen or Narrow: Narrow, sold more expensive (2853.10)
Later, the positions are offset when:
September E-mini S&P 500 are 2840.20 points December E-mini S&P 500 are 2807.50 points
Spread: 32.70 points
Widened or Narrowed: Widened
Profit or Loss: Loss
Amount: $517.50 (10.35 widening x $50 per point)
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 50
Activity #17 – Spreads 1. A client believes that there will be a
bullish run on soybeans. Which of the following spreads is the most appropriate?
2. A client believes that there will be a bullish run on euros. Which of the following spreads is the most appropriate?
a. Buy the nearby and sell the deferred b. Sell the nearby and buy the deferred c. Sell the nearby and sell the deferred d. Buy the nearby and buy the deferred
a. Buy the nearby and sell the deferred b. Sell the nearby and buy the deferred c. Sell the nearby and sell the deferred d. Buy the nearby and buy the deferred
Activity #18 – Spread – Profit or Loss A customer has a spread position in pork bellies. She’s long July at 38.50 cents and short December at 52.50 cents. Later, she liquidates her spread when July is at 46.25 and December is at 63.75. The size of the contract is 40,000 lbs. What’s her profit or loss, excluding commissions?
a. $1,400 profit b. $1,400 loss c. $140,000 profit d. $140,000 loss
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 51
Chapter 9 – Hedging
Hedgers Through hedging, producers and users may pass most of the risk of price change to speculators Producers are businesses that either currently possess or will produce the commodity for sale and delivery at some future date Producers are long the cash commodity and fearful of falling prices
Users are currently without the commodity, but have an absolute use for the commodity and will need to buy at some future date Users are short the cash commodity and fearful of rising prices
Overview of Hedgers Producer Overview Item User
Long ← Cash Commodity (Basis) → Short
Falling Prices ← Fear → Rising Prices
Selling Hedge/Short Futures ← Establishes → Buying Hedge/Long Futures
Short Hedger ← What Kind of Hedger? → Long Hedger
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 52
Activity #19 Determine whether each hedger is a PRODUCER or USER.
CORN FARMER
GOLD JEWELRY COMPANY
AMERICAN IMPORTER
A CORPORATE BOND ISSUER
OIL REFINERY
AMERICAN EXPORTER
Basis and Basis Charge A hedger’s basis is the difference between the hedger’s cash price and futures price In a normal market, cash is less than futures – “cash under” In an inverted market cash is more than futures – “cash over”
$3.00$3.10$3.20$3.30$3.40$3.50
Cash July September December
Corn Prices Basis Change from Entering to Lifting Hedge Producer User
Gain on the Hedge if:
In a normal market, this means the basis:
Basis is $0.10 under if July futures are used to hedge
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 53
Basis Change Cash Futures Basis
Now: $3.45 $3.57
Later: $3.62 $3.70
Did the basis strengthen or weaken?
Did the basis widen or narrow?
Basis Change Cash Futures Basis
Now: $7.58 $7.64
Later: $7.65 $7.75
Did the basis strengthen or weaken?
Did the basis widen or narrow?
0 ¢
- 5 ¢
- 10 ¢
- 15 ¢
Strengthen Remember – A strengthening basis will be profitable for producers
0 ¢
- 5 ¢
- 10 ¢
- 15 ¢
Weaken Remember – A weakening basis will be profitable for users
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 54
Basis Change Cash Futures Basis
Now: $8.45 $8.37
Later: $8.60 $8.44
Did the basis strengthen or weaken?
Did the basis widen or narrow?
Basis Change Cash Futures Basis
Now: $12.79 $12.68
Later: $12.70 $12.66
Did the basis strengthen or weaken?
Did the basis widen or narrow?
0 ¢
10 ¢
5 ¢
15 ¢
Strengthen Remember – A strengthening basis will be profitable for producers
0 ¢
10 ¢
5 ¢
15 ¢
Weaken Remember – A weakening basis will be profitable for users
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 55
Activity #20 Determine whether each statement is TRUE or FALSE.
1 A producer is short the basis.
2 A user will profit if the basis strengthens.
3 A user is short the basis.
4 In a normal market, a strengthening basis will be narrower.
5 In an inverted market, a weakening basis will be narrower.
6 A producer that establishes a hedge with a basis of $0.40 over will lose if the basis ends at $0.50 over.
7 A user that establishes a hedge with a basis of $0.50 under will profit if the basis ends at $0.60 under.
The Result of the Hedge With the spot market for wheat at $5.87, a farmer with wheat in her silo chooses to hold it for later sale. She hedges by selling futures at $5.99. Later, in July, she sells the wheat in the spot market for $5.82 and covers the short position for $5.90. What’s the net result of the hedge?
Cash Futures Basis
March Long at $5.87 Short at $5.99
July Sells at $5.82 Long at $5.90
Change -$0.05 +$0.09
The overall result of the hedge is an increase in the “cash now” price of $0.04
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 56
Effective Selling Price 1) Cash
Now +/- Hedge Result
$5.87 cash now + $.04 profit on hedge = $5.91
2) Cash Later +/- Futures
Result
$5.82 cash later + $.09 profit on futures = $5.91
Effective Selling Price Producers A gain on the hedge or futures will increase the producer’s selling price (i.e., revenue) A loss will decrease the producer’s effective selling price
1) Effective Selling Price = Cash Now + Profit on Hedge or Cash Now – Loss on Hedge 2) Effective Selling Price = Cash Later + Profit on Futures or Cash Later – Loss on Futures
Effective Cost Producers A gain on the hedge or futures will decrease the user’s cost (i.e., expenses) A loss will increase the user’s effective cost
1) Effective Cost = Cash Now – Profit on Hedge or Cash Now + Loss on Hedge 2) Effective Cost = Cash Later – Profit on Futures or Cash Later + Loss on Futures
Two Methods:
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 57
Hedging Exercise Exercise 1: A farmer is long cash soybeans. The current cash price is $7.00 bushel. He sells futures at $7.25 per bushel. Three months later, the farmer sells his cash soybeans at $6.90 and simultaneously buys his futures back at $7.05. What’s the result of the hedge?
Producer (long cash) or User (short cash)? What type of hedge? Cash Futures Basis
Now
Later
Change
Hedging Exercise Exercise 1 Continued: What’s the hedger’s effective selling price or effective cost?
Effective selling price or cost? Cash Futures Basis
Now Long at $7.00 Short at $7.25 $0.25 under
Later Sell at $6.90 Long at $7.05 $0.15 under
Change -$0.10 +$0.20 $0.10 str. 1) Cash Now +/- Hedge Result
$7.00 + $0.10 =
2) Cash Later +/- Futures Result
$6.90 + $0.20 =
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 58
Hedging Exercise Exercise 2: An American importer places an order with a Swiss manufacturer. The order, which is to be delivered in August, is valued at 2,000,000 Swiss francs. The cash price for the franc is $1.5975 and September futures are trading at $1.5715. When the hedge is lifted, the cash price of the francs is $1.6135 and the futures are at $1.5855. What’s the result of the hedge?
Producer (long cash) or User (short cash)? What type of hedge? Cash Futures Basis
Now
Later
Change
Hedging Exercise Exercise 2 Continued: What’s the hedger’s effective selling price or effective cost?
Effective selling price or cost? Cash Futures Basis
Now S $1.5975 L $1.5715 $0.0260 over
Later L $1.6135 S $1.5855 $0.0280 over
Change -$0.160 +$0.0140 $0.0020 str. 1) Cash Now +/- Hedge Result
$1.5975 + $0.0020 =
2) Cash Later +/- Futures Result
$1.6135 – $0.0140 =
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 59
Activity #21 – Calculating Effective Cost A firm that’s short the basis establishes a hedge using two corn futures contracts. When the hedge is placed, the cash price is at $5.00 and futures are at 5.30 and the firm's basis is 30 cents under. When the hedge is lifted, the basis is 24 cents under. The futures contract size is 5,000 bushels. When the hedge is lifted, the company buys corn. The change in basis means that the company will have an effective cost of: a. $0.06 b. $5.06 c. $4.94 d. $5.00
Hedging Exercise Exercise 3:
A corporation issues bonds with a price of 94-17. The corporation intends to issue another $10 million in April and wants to hedge its anticipated offering. T-Bond futures prices are as follows:
March: 96-10 Sept: 95-29 June: 96-19 Dec: 90-02
Later, the bonds are issued at 90-06 and futures are offset at 91-27. What’s the result of the hedge?
Producer (long cash) or User (short cash)?
What type of hedge? Cash Futures Basis
Now
Later
Change
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 60
Hedging Exercise Exercise 3 Continued: What’s the hedger’s effective selling price or effective cost?
Effective selling price or cost? Cash Futures Basis
Now L 94 17/32 S 96 19/32 2 2/32 under
Later S 90 6/32 L 91 27/32 1 21/32 under
Change -4 11/32 +4 24/32 0 13/32 str. 1) Cash Now +/- Hedge Result
94 17/32 + 0 13/32 =
2) Cash Later +/- Futures Result
90 6/32 + 4 24/32 =
Hedging Exercise Exercise 3 Continued: What’s the total amount raised from the issuance of the bonds?
What did the hedge do to the issuer’s interest costs? Cash Futures Basis
Now L 94 17/32 S 96 19/32 2 2/32 under
Later S 90 6/32 L 91 27/32 1 21/32 under
Change -4 11/32 +4 24/32 13/32 str. Total Issuance? Interest Costs?
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 61
Hedging Exercise Exercise 4: An electrical wire manufacturer enters a hedge when cash copper is at 366 cents and the December futures are at 367.75 cents. The manufacturer closes the hedge when cash is at 367.10 cents and the futures are at 368.85 cents. What’s its effective cost for the copper?
Effective selling price or cost? Cash Futures Basis
Now S $3.6600 L $3.6775 $0.0175 under
Later L $3.6710 S $3.6885 $0.0175 under
Change -$0.0110 +$0.0110 No Change 1) Cash Now +/- Hedge Result
$3.66 + $0.0000 =
2) Cash Later +/- Futures Result
$3.6710 – $0.0110 =
Activity #22 – Calculating Effective Cost An oil refinery needs 45,000 barrels of crude oil. When its hedge is placed, the cash price of crude oil is $60.75 per barrel. It hedges by using 45 July crude oil futures contracts. The futures hedge is established at a price of $61.05. When the hedge is lifted, the refinery buys crude oil in the cash market at $80.62 and its futures position is offset at $83.10. The net price per barrel the oil driller pays as a result of the hedge is: a. $58.57 b. $82.80 c. $85.28 d. $80.92
Cash Futures Basis
Now S $60.75 L $61.05 $0.30 under
Later L $80.62 S $83.10 $2.48 under
Change - $19.87 + $22.05 + $2.18 weak (profit for user)
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 62
Chapter 10 – Stock Index Futures
Stock Index Futures Index futures contracts use a multiplier to convert an index value or average into a dollar value
Non-Systematic Risk Individual stock risk A combination of industry risk and
company risk
Systematic Risk Overall market risk Cannot be eliminated through
diversification
Stock Indexes Multiplier Minimum Tick Value
S&P 500 $250 0.10 points = $25
E-mini S&P 500 $50 0.25 index points = $12.50
E-mini Nasdaq 100 $20 0.25 index points = $5.00
DJIA $10 1 index point = $10
E-mini DJIA $5 1 index point = $5
E-mini Russell 2000 $50 0.10 index points = $5.00
Index futures contracts are cash settled
Stock index futures are used to hedge systematic risk
Non-systematic risk can be reduced through diversification
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 63
Stock Index Futures Application A customer places an order to buy three S&P 500 futures contracts. The multiplier is $250 per index point. The initial margin requirement is $66,000 per contract and the maintenance is $60,000 per contract. The customer deposits the required margin in his account. The customer's order is filled and a long position of three contracts is established at 2833.30. That night, the settlement price for the December futures contract is 2825.80. Calculate the current equity in the customer's account.
Settlement: 2825.80 Loss: 7.5 points
Long: -2833.30 Multiplier: x $250
Loss: 7.5 points Total Loss: ($1,875) open trade equity (OTE)
Cash Balance OTE Equity
Equity per contract $66,000 ($1,875) $64,125 Total Equity: $64,125 equity per contract x 3 contracts = $192,375
Activity #23 – Hedging Stock Portfolios A customer has a large blue-chip stock portfolio. She anticipates a market decline and wants to hedge $5,000,000 of the portfolio using the S&P 500 futures. Each index point equals $250. The futures price is currently 2,995.20. Which of the following is the best hedging strategy? a. Buy 20 S&P 500 contracts b. Sell 20 S&P 500 contracts c. Buy 6 S&P 500 contracts d. Sell 6 S&P 500 contracts
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 64
Chapter 11 – Commodity Options
Options Overview An option is a contract between two parties
BUYER SELLER Long the option Pays the premium (DEBIT) Acquires a right/control
Short the option Receives the premium (CREDIT) Assumes an obligation
Types of Contracts If an option is exercised…
BUYER’S RIGHT SELLER’S OBLIGATION
CALL
PUT
For an option, the underlying asset is a futures position, not a cash position
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 65
In-the-Money Versus Out-of-the-Money
In, At, or Out-of-the-Money Option Market Price In, At, or Out-of-the-Money?
September 320 Corn Call at 16.75 336.50 cents
September 320 Corn Put at .50 336.50 cents
Oct 1750 Gold Put at 11.70 $1,739
Feb 1.0500 Gasoline Call at 0.35 $1.05
June 110 T-bond Call at 4-22 113-17
STRIKE PRICE
$50 $50
$70 $70
$60 $60
CALLS: In-the-Money
PUTS: Out-of-the-Money
CALLS: Out-of-the-Money
PUTS: In-the-Money
Market Price
Market Price
Calls and Puts are At-the-Money if the option’s strike price is equal to the future’s market price.
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 66
An Option’s Premium
A contract has intrinsic value if it’s in-the-money. Its intrinsic value equals its in-the-money amount. It has zero intrinsic value if it’s out-of-the-money or at-the-money.
Time value is set in the market (negotiated) and is based on: Time left until expiration Market volatility
Intrinsic Value and Time Value Option Market Price Intrinsic Value Time Value
September 320 Corn Call at 16.75 336.50 cents
September 320 Corn Put at .50 336.50 cents
Oct 1750 Gold Put at 11.70 $1,739
Feb 1.0500 Gasoline Call at 0.35 $1.05
June 110 T-bond Call at 4-22 113-17
PREMIUM = Intrinsic Value + Time Value
The amount by which an option is in-the-money
The portion of an option’s premium that exceeds its intrinsic value
INtrinsic value is only created if an option is IN-the-money.
T-bond Option premiums are quoted in 1/64ths
T-bonds are quoted in 32nds
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 67
Bond Calculations Converting 32nds into 64ths
113 17/32 - 100 0/32 3 17/32
Subtracting Fractions
4 22/64 - 3 34/64 1 12/32
Activity #24 – T-Bond Options A customer sells a T-bond call at 5-30. Later, if she covers the call at 4-22, the result is: a. Profit of $1,125 b. Loss of $1,125 c. Profit of $1,250 d. Loss of $1,250
Basic Options: Long and Short Calls CALLS BUYER, OWNER, LONG SELLER, WRITER, SHORT
RIGHTS Buy futures at strike price None
OBLIGATIONS None Sell futures at strike price
STRATEGY Bullish ↑ Bearish ↓
BREAKEVEN Strike price + premium Strike price + premium
MAXIMUM GAIN Unlimited Premium
MAXIMUM LOSS Premium Unlimited
3 17/32 x 2/2 [3] [17 x 2] / [32 x 2]
Remember: 1/32 = $31.25 and 1/64 = $15.625
4 22/64
[4 – 1] [22/64 + 64/64]
3 86/32
3 86/64 - 3 34/64
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 68
Long Call – Analysis When the current market value of feeder cattle is:
Buy 1 May Feeder Cattle 130 Call at 1.50
BREAKEVEN:
Basic Options: Long and Short Puts PUTS BUYER, OWNER, LONG SELLER, WRITER, SHORT
RIGHTS Sell futures at strike price None
OBLIGATIONS None Buy futures at strike price
STRATEGY Bearish ↓ Bullish ↑
BREAKEVEN Strike price – premium Strike price – premium
MAXIMUM GAIN (Strike price – premium) x contract size Premium
MAXIMUM LOSS Premium (Strike price – premium) x contract size
130 cents per pound (50,000 lbs. per contract)
DEBIT CREDIT
STRATEGY:
MAXIMUM GAIN:
MAXIMUM LOSS:
Later, with feeder cattle at 140 cents, the investor exercises the option and immediately sells the futures contract. Result?
0
130
131.5
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 69
Short Put – Analysis When the current market value of the euro is:
Buy 1 May Euro 1.10 Put at 0.0350
BREAKEVEN:
Straddles and Combinations Created by either: Buying both a call and a put on the same underlying futures contract OR Selling both a call and a put on the same underlying futures contract
Strategy Long straddle or combination: Short straddle or combination:
STRADDLE: Same expiration months and strike
prices
COMBINATION: Different expiration months and/or
strike prices
$1.10 (125,000 euros per contract)
DEBIT CREDIT
STRATEGY:
MAXIMUM GAIN:
MAXIMUM LOSS:
Later, when euros are $0.95, the investor’s option is exercised and the futures contract is sold. Result?
0
$1.065
$1.10
If an investor has one option component and adds another to create a multiple option position, he’s considered to have legged into the position.
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 70
Long Straddle – Analysis Uncertain of the exact direction in which golf is going to move, an investor:
BREAKEVEN POINTS:
STRATEGY:
MAXIMUM GAIN:
MAXIMUM LOSS:
Spreads Positions which allow an investor to limit losses in exchange for limiting gains Created with the sale and purchase of two options of the same class, but different series
− Class: options of the same type on the same underlying security − Series: options of the same class, same expiration, and same strike prices
Spreads may be either bullish or bearish and either debit or credit
Price/Dollar/Vertical Buy 1 Jul Wheat 500 Call Sell 1 Jul Wheat 510 Call
Time/Calendar/Horizontal
Buy 1 Dec Silver 18 Call Sell 1 Aug Silver 18 Call
Diagonal
Buy 1 Aug Hog 58 Put Sell 1 Oct Hog 50 Put
Buys 1 June Gold 1750 Call at 33 Buys 1 June Gold 1750 Put at 28 (contract size 100 troy ounces)
The total (combined) premium is __________ 1,750
0
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 71
Call Spread – Analysis An investor who’s bullish on the S&P 500 establishes the following positions:
SPREAD RULES: The breakeven must be between the strikes. The max gain PLUS the max loss will equal the
difference in the strike prices.
Put Spread – Analysis An investor who’s bullish on the price of soybeans establishes the following positions:
SPREAD RULES: The breakeven must be between the strikes. The max gain PLUS the max loss will equal the
difference in the strike prices.
Long 1 S&P 500 Mar 2910 Call at 49 Short 1 S&P 500 Mar 2950 Call at 32 ($250 per point)
Net Premium: Buyer or Seller: Debit or Credit: Widen or Narrow: Breakeven: Bull or Bear: Maximum Gain: Maximum Loss:
2950
2910
Short 1 Sept Soybeans 810 Put at 7 Long 1 Sept Soybeans 800 Put at 3 (5,000 bushels)
Net Premium: Buyer or Seller: Debit or Credit: Widen or Narrow: Breakeven: Bull or Bear: Maximum Gain: Maximum Loss:
810
800
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 72
Delta When the price of May wheat is $3.80, an investor buys a May Wheat 400 call for $0.35. Later, May wheat rises to $4.20 and the call’s premium has increased to $0.55. What’s the call’s delta?
Activity #25 Estimating Option Premium with Delta
June gold futures are trading at $1,752 per ounce. The June 1760 gold call option is trading at $10.20 per ounce. The call’s delta is 40%. If gold rallies to $1,774 per ounce, what’s the expected premium on the call?
Change in futures price: Change in option premium: New option premium:
Using Options to Hedge Since option premiums only move a percentage of the underlying futures, hedgers will need to buy more options to effectively hedge Out-of-the-money options have low deltas At-the-money options have deltas around 50% In-the-money options have high deltas, approaching 100%
= Change in Option Premium
Change in Futures Price
Rather than using futures, hedgers can use options to protect their cash positions Producers will buy puts Users will buy calls
Number of Options = Number of Futures
Option’s Delta
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 73
Activity #26 – Using Options to Hedge A farmer needs 60 futures contracts to hedge this year’s production. How many put contracts will she need if:
The delta is 0.5? The delta is 0.9? The delta is 0.08?
Margin on Options Buying Options Selling Options
The margin deposit is 100% of the option’s premium A trader buys a June copper 2.5000
call for a premium of $0.0500. If the copper contract size is 25,000 pounds, what’s the margin deposit?
• Margin = $0.05 premium x 25,000 lbs.
• Margin = $1,250
The margin deposit for selling options is:
The initial margin on the futures contract
+ The option’s premium
– 50% of the out-of-the-money amount
Activity #27 – Short Option Margin When Dec corn is trading at $3.70, an investor shorts 1 Dec corn $3.80 corn call at $0.15. Dec corn has an initial margin requirement of $0.40 and a size of 5,000 bushels. What’s the investor’s margin requirement?
Futures margin? Premium? 50% of the out-of-the-money? Total?
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 74
Synthetic Positions Synthetic Long Futures = Long Call and Short Put
Synthetic Short Futures = Long Put and Short Call
Synthetic Long Call = Long Put and Long Futures
Synthetic Long Put = Long Call and Short Futures
Conversion = Long Futures and Long Put and Short Call
Reversal = Short Futures and Long Call and Short Put
Mastering Synthetics Algebra: 5 – 2 = 3
Start: Long Call = Long Put + Long Futures
Synthetic Short Futures?
Start: Long Call = Long Put + Long Futures
Answer:
Series 3 On-Demand Learning Guide
800-782-1223 stcusa.com 75
Activity #28 – Synthetics 1. Which of the following is equivalent to a long futures position?
a. Long two puts b. Short a call and long a put c. Short a call and short a put d. Long a call and short a put
2. Which of the following is equivalent to a short put position?
a. Long a call and long a put b. Short a call and long a futures contract c. Short a call and short a futures contract d. Long a call and short a put