© NYSE Euronext. All Rights Reserved. An Introduction to Commodity Derivatives NYSE Liffe Soft &...

© NYSE Euronext. All Rights Reserved.

An Introduction to Commodity DerivativesNYSE Liffe Soft & Agricultural CommoditiesUniwersytet Łódzki Wydział Ekonomiczno - Socjologiczny

4 March 2011

22

Legal DisclaimerCautionary Note Regarding Forward-Looking Statements

This presentation may contain forward-looking statements, including forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include, but are not limited to, statements concerning NYSE Euronext's plans, objectives, expectations and intentions and other statements that are not historical or current facts. Forward-looking statements are based on NYSE Euronext's current expectations and involve risks and uncertainties that could cause actual results to differ materially from those expressed or implied in such forward-looking statements. Factors that could cause NYSE Euronext's results to differ materially from current expectations include, but are not limited to: NYSE Euronext's ability to implement its strategic initiatives, economic, political and market conditions and fluctuations, government and industry regulation, interest rate risk and U.S. and global competition, and other factors detailed in NYSE Euronext’s reference document for 2007 ("document de référence") filed with the French Autorité des Marchés Financiers (Registered on May 15, 2008 under No. R.08-054), 2007 Annual Report on Form 10-K and other periodic reports filed with the U.S. Securities and Exchange Commission or the French Autorité des Marchés Financiers. In addition, these statements are based on a number of assumptions that are subject to change. Accordingly, actual results may be materially higher or lower than those projected. The inclusion of such projections herein should not be regarded as a representation by NYSE Euronext that the projections will prove to be correct. This presentation speaks only as of this date. NYSE Euronext disclaims any duty to update the information herein.

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Agenda

• Background to Commodity Markets

• Users of Futures & Options

• NYSE Liffe Commodity Derivatives

• Key Soft Commodities

• Key Agricultural Commodities

• NYSE Liffe Commodities: How to Access the Markets

• Contract Specifications & Expiry Schedule

• Questions

Speaker:Aaron Gill – Head of Business Development, Commodity Derivatives, NYSE Liffe

Background to Commodity Markets

5

The Commodities Markets

Energy – Crude Oil, Gasoil, Natural Gas, Coal, Electricity etc.

Grains and Oilseeds – Corn, Soya, Wheat etc.

Metals – Base and Precious

Softs – Coffee, Cocoa, Sugar etc.

Fibres – Cotton, Lumber etc.

Livestock – Cattle, pigs etc.

6

Major Factors That Affect Commodity Markets

Supply and Demand

Currencies (Exchange Rates)

Transport

Weather

Politics

Labour Costs

Inflation

….And a recent development is the investment factor – i.e. the emergence of commodity funds (more on the funds later)

…..not necessarily in order of importance. Besides, they are all linked, influenced by - and dependent on each other

In fact – we could turn it all on it’s head – because the price of commodities can affect all of the above!!

7

Supply and Demand

Supply and demand are important in equity markets of course – but not to the same extent as in the commodities markets. Demand might change in equities but supply (generally speaking) does not

In commodities, both demand and supply can change

Supply can be increased, but it can’t always be increased quickly

Major Factors That Affect Commodity Markets

8

Market Participants / Client Types

Growers (‘Origin’) / Producers / Cooperatives

Manufacturers / Refiners / Merchants / Processors

Banks / Hedge Funds / Index Funds / Exchange Traded Funds

9

Bigger Names You Might Recognise (or Maybe Not? )

Commodity Firms - ADM (Archer Daniels Midland), Bunge, Cargill, Louis Dreyfus, Glencore, ED&F MAN, Armajaro, Masterfoods (Mars), Nestle, Kraft, Barry Callebaut

Funds – Deutsche Bank, Barclays, Goldman Sachs, Pimco Commodity Real Return Fund, Oppenheimer Real Asset Fund, Diaposon Rogers Commodity Index Fund

Hedge Funds – GLG Partners, Moore Capital, Bridgewater Associates, Man Investments, Goldman Sachs Asset Management, to name a few!

…..and then of course there are the independent traders in the American ‘pits’ (although the markets are migrating towards screen-based trading at the time of writing) – plus there is growing interest from trading bureaux i.e. you!

It is important to understand that whilst the commodity markets are smaller in volume terms than the financial markets, they are truly global markets – they are not controlled by a select band of traders in New York or London

Users of Futures & Options

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Futures: The Basics

• A Futures contract is an agreement to buy or sell a standardised commodity on a fixed date in the future – with the price agreed now

• Futures enable users to gain exposure to price movements in an underlying commodity but without necessarily having to sell or buy physical stocks

• The buyer does not have to pay the full cash value for the commodity and the seller does not have to deliver the commodity (until expiry/delivery). They both simply have to deposit a small (returnable) security deposit (known as a margin payment) to guarantee they will not default in the event of a loss if the value of the contract changes.

Futures: The Basics

• Futures traded on Exchanges are contracts to buy or sell standardised quantities (“lots”) of a commodity on standardised dates (“expiry”) fixed by the exchange.

• e.g.– Standardised quantity: One Milling Wheat Futures Contract

equals 50 tonnes of milling wheat

– Standardised dates (“expiry”): the expiry date for a Milling Wheat Futures Contract is the tenth business day of the delivery month. There are several stipulated delivery months available for trading - in order to offer standardisation and flexibility to market users. For the Milling Wheat contract it is Jan, Mar, May, Aug, Nov such that 8 delivery months are available for trading .

Futures: The Basics

• A further standardised feature is the “minimum price movement” (or “tick size”)

• e.g.:

– Milling Wheat minimum price movement = 25 Euro cents per tonne (i.e. the market cannot move in intervals of less than 25 Euro cents).• e.g. Milling wheat price moves from €258 up to €258.25

– 1 Milling Wheat Futures Contract = 50 tonnes of milling wheat

– Therefore the “Tick Value” = €12.50 (50 tonnes x 25 Euro cents).

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Users of Commodity DerivativesThe two most common reasons for using the NYSE Liffe Commodity futures markets are hedging and investment:

• Hedgers look to protect themselves from adverse price movements and typically include:– Producer co-operatives– Trade houses– Commodity processors– Food and animal feed manufacturers

• Investors look to make profit from favourable price movements and include:– Hedge funds– Institutional investors– Independent proprietary traders

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Principles of Hedging using Derivatives

• Hedgers look to protect themselves from adverse price movements

• This is usually achieved by taking an opposite position in the futures market to their position in the physical market

• Hence, any loss in the physical market will be offset by a profit in the futures market and vice versa

• Hedging enables market users to “lock” in a price many months in advance of making or taking delivery of the physical commodity

• Futures are primarily used as a financial instrument i.e. futures positions will be “closed out” prior to the point of expiry – Physical delivery will take place through normal physical market channels – the

futures market is the “delivery market of last resort”

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Principles of Investment using Derivatives

• Investors are looking to gain exposure to the price movements in a particular commodity – but without the need to hold stocks of the physical product

• Investors play a valuable role in the market by taking on the price risk that hedgers are trying to offset

• If an investor believes the market price will increase he is “bullish” and is likely take a long (bought) position in the market with a view to selling the position back to the market at a later date for a profit

• If an investor believes the market price will decrease he is “bearish” and is likely take a short (sold) position in the market with a view to buying the position back at a later date for a profit

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Other Roles of the Derivatives market

• As a neutral and central marketplace, derivatives markets play a valuable role in creating price transparency for the underlying asset or financial instrument

• The futures price is often the only visible price benchmark for participants in the underlying physical market

• Hence many physical contracts are concluded at a premium, discount or ratio to the prevailing futures price

• Even if you are not using the market directly it is important to be aware of what is happening in the futures markets

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How futures work – entering a “short” position

• Futures enable users to gain exposure to price movements in an underlying commodity but without necessarily having to sell or buy physical stocks

• e.g. sell 1 lot of November 2010 Robusta Coffee futures at a price of $1700 per tonne, you are entering into a contract to:

– Deliver 10 tonnes of Robusta Coffee (In Store, Exchange Nominated Warehouse) in November 2010 at a price of $1700 per tonne (total contract value of $17,000)

– To enter into this contract you will need to pay a deposit – otherwise known as an initial margin (currently $1100 per 10 tonne lot)

• You are now short (have sold) one lot of November 2010 Robusta Coffee futures

• At the end of every day the value of your futures position will be “marked to market” (re-valued) and any profit/loss will be credited/debited to your account (these payments are known as variation margin)

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How futures work – closing your short position

• At a later date, prior to the expiry of the November 2010 delivery month, the November 2010 futures price has dropped to $1650 per tonne

• Having sold 1 lot at $1700 (per tonne) your margin account is now $50 per tonne in credit

How do you realise this profit….?

• You BUY an November 2010 futures contract at the prevailing price of $1650 per tonne

• This bought (long) position will offset your sold (short) position

• The two offsetting positions will cancel each other out and, in this example, there is a $50 per tonne gross profit on the futures trade

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How futures work – delivering to the futures market

• Instead of “buying back” and offsetting your short position you could leave it until the delivery month (November 2010) expires and then deliver 10 tonnes of Robusta Coffee, In Store, Exchange Nominated Warehouse (at the price at which you entered the futures contract)

• In practice, only around 1% of futures trades go to physical delivery; the rest are closed out (offset) before the point of physical delivery

• Futures markets are known as the “delivery market of last resort”

• The delivery mechanism exists to ensure that convergence between the physical and futures price takes place

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How futures work – entering a “long position”

• It is also possible to enter a bought (“long”) position

• e.g. buy 1 lot of November 2010 Robusta Coffee futures at a price of $1700 per tonne, you are entering into a contract to:

– Take delivery of 10 tonnes of Robusta Coffee (In Store, Exchange Nominated Warehouse) in November 2010 (total value of $17,000) at a price of $1700 per tonne

– To enter into this contract you will need to pay an initial margin

• You are now long (have bought) one lot of November 2010 Robusta Coffee futures at $1700 per tonne

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How futures work – closing your long position

• At a later date, prior to the expiry of the November 2010 delivery month, the November 2010 futures price has dropped to $1650 per tonne

• Having bought 1 lot at $1700 your margin account is now showing a $50 per tonne loss

How do you close this position and cut your losses….?

• You SELL one November 2010 futures contract at the prevailing price of $1650 per tonne. This sold (short) position will offset your bought (long) position

• The two offsetting positions will cancel each other out and, in this example, there is a $50 per tonne gross loss on the futures trade

NYSE Liffe Commodity Derivatives

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NYSE Liffe Commodities - Overview

• Commodity futures & options are traded on LIFFE CONNECT®, the world’s most widely accessible electronic trading platform – 800+ locations in 30 countries

• Commodity futures & options are listed on Cocoa, Robusta Coffee, White Sugar, Feed and Milling Wheat, Rapeseed, Malting Barley, Corn and Skimmed Milk Power (SMP)

• The increasing popularity of NYSE Liffe Commodity futures and options for hedging and investment purposes has led to nearly a decade of growth

• Average daily volume for NYSE Liffe Commodities YTD 2010 was 70k contracts

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NYSE Global Derivatives - Overview

NYSE Liffe Clearing NYPC

U.S. FuturesEurope U.S. Options

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NYSE Liffe Commodities - Overview• NYSE Liffe is a world-leading provider of softs & agricultural commodity derivatives –

the futures contracts act as “price benchmarks” for their respective underlying physical markets– Global benchmarks = Cocoa, Robusta Coffee, White Sugar– European benchmarks = Milling Wheat, Feed Wheat, Rapeseed, Corn, Malting Barley– New contract – Skimmed Milk Powder (launched October 2010)

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Opportunities in Softs and AgriculturalsNew Horizons

• Food for fuel debate led to increased demand for land and agricultural products

• Continued strong growth in demand for corn and sugar based ethanol

• Credit and counter party default risk remains a concern in current market conditions

• Changing regulatory environment globally

• Strong increase in use of exchange listed futures and options on softs and agricultural products

Trading Opportunities• Market volatility: intra-day trading range = trading opportunities

• Active calendar spread market, especially during the roll period and certain key times of the growing season e.g. Dec/March in Cocoa, Nov/Jan in Robusta Coffee, March/May in White Sugar and May/Nov in Wheat

• Active arbitrage between US and European markets

• Majority of activity in NYSE Liffe softs and ags market is from commercial participants who use these contracts for hedging

Increased Activity• Volumes for Soft and Agricultural commodities traded at NYSE Liffe increased by 50% over past two years

• Particularly strong growth in futures and options on Milling Wheat over past three years

• 2010 vs 2009: Milling Wheat F&O + 120%

2009 vs 2008: Milling Wheat F&O +130%

2008 vs 2007: Milling Wheat F&O +57%

• Opportunity for funds and proprietary trading groups to increase activity and trade with commercial participants

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Coffee Background Information

• Generally, coffee is grown within 1,000 miles of the equator, from the Tropic of Cancer in the north, to the Tropic of Capricorn in the south

• Coffee grows in more than 50 countries and is the second largest export in the world after oil (in dollar value)

• Central and South America produce approximately two thirds of the world's coffee supply

• The main suppliers of coffee in the world are Brazil, Colombia and Vietnam, with Brazil contributing around 30% of the total

• The coffee tree produces its first full crop when it is about five years old. Thereafter it produces consistently for 15 to 20 years

• There are two main commercial types of coffee bean - these are Robusta and Arabica.

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Coffee Growing Regions

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Robusta Coffee

• The term ‘Robusta' is the name of a widely grown variety of this species

• Arabica is used for quality coffee, while the robusta, which produces a thick, stronger liquor, is suitable for blending and for the production of instant coffee

• Robusta coffee is grown in West and Central Africa, throughout South-East Asia and to some extent in Brazil, where it is known as Conillon.

• Over recent years, Vietnam has become a major Origin of Robusta Coffee, producing 40% of the world’s Robusta Coffee supply

• Robusta coffee grows best at lower altitudes (Arabica is better suited to higher altitudes)

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Coffee TimelinesPre-1000 A.D: The Galla tribe in Ethiopia noticed that they got an energy boost when they ate coffee berries which were ground up and mixed with animal fat

1000 A.D: Arab traders brought coffee back to their homeland and cultivated the plant for the first time on plantations. They also began to boil the beans, creating a drink which they called "qahwa" - the literal translation being 'that which prevents sleep'

1500: In the days of the Ottoman empire, around 1500, coffee houses sprang up in cities such as Cairo, Aleppo and Damascus. Coffee-drinking became an essential part of social and business rituals. Through European merchants trading in the eastern Mediterranean coffee was gradually introduced into Europe, through Venice, Genoa and Marseilles

1652: First coffee house in Britain opens

1958: Trading of “coffee futures” at the Coffee Terminal Market, London begins

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Coffee - A Global Commodity

• Coffee – one of the most valuable primary products in world trade

• Second in value only to oil as a source of foreign exchange to developing countries

• Its cultivation, processing, trading, transportation and marketing provide employment for millions of people worldwide

• Futures and options contracts traded in London (Robusta Coffee), Tokyo (Robusta Coffee) and New York (Arabica)

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Robusta Coffee Futures: Who, What, Why• 2 main types of coffee – Robusta and Arabica• Robusta coffee accounts for 35% of world production, of which 40% is produced by Vietnam; Robusta

supply more volatile• Main crop harvest in Vietnam occurs around October/November, making the November and January

delivery months most active for hedging• Prices can be significantly affected by frost and drought• Main consumers are USA, EU and Brazil• Stocks play important part of Supply and Demand equation• Outright bid/ask spread between 1 to 4 ticks wide; majority of activity is in the front three delivery

months• Robusta Coffee trades outrights and spreads (calendar spreads predominantly used)• Options open interest good indicator: build up of OI tends to indicate futures movement• Spread prices reflect cost of carry (warehouse rent, insurance, grading) together with fundamentals

and market sentiment• Backwardation – common in the commodity markets• Strong volatility (ATM 24%) • Arbitrage with NY contract very important, accounts for 20 - 30% of volume; market activity increases

when NY opens• ADV in 2010 is 12K lots • Reports: Brokers, stocks (NYSE Liffe and ICE), grading results, ICO forecasts and figures, USDA,

weather • Arb: (ICE * 2204.6) – NYSE Liffe

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Robusta Coffee Futures Contract Specification

Unit of Trading Ten tonnes

Origins tenderable Robusta coffee that from any Origin that is freely available for export to any destination

Quality Class 1 Robusta Coffee deliverable to Contract price (other qualities deliverable at set premiums and discounts)

Delivery Months January, March, May, July, September, November such that ten delivery months are available for trading

Price Basis US dollars per tonne in an Exchange Nominated Warehouse in Europe or the USA

Min Price Movement

(Tick Value)

$1 per tonne ($10)

Last Trading Day Last business day of the delivery month at 12:30

Notice Day Any business day during the delivery month

Trading Hours 09:00 – 17:30 (London time)

Algorithm Pro-rata trading algorithm with priority given to first order at the best price, subject to a minimum order volume and limited to a maximum volume cap

35

Robusta Coffee Futures: Volume and OI

*Robusta Coffee contract size was changed from 5 tonne to 10 tonne in March 09.

36

Robusta Coffee Options: Volume and OI

*Robusta Coffee contract size was changed from 5 tonne to 10 tonne in March 09.

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Robusta Coffee Futures Settlement PriceSecond Month Continuation Chart: Jan 08-Present$/tonne

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Milling Wheat Futures: Who, What, Why• Seasonality: European wheat crop is harvested in JULY

• EU 27 Production around 140 MT in 2009 ie 20% of World Production (673 MT in 2009)

• Main European producers are France, Germany and UK. Europe is an exporter area

• Strong volatility (35%) during these last 3 years with high peaks in Sept 07, Feb 08 and Jul 09

• New operators on the market coming from Eastern European countries

• The curve: 6 out of 8 delivery months are traded with 1 to 3 ticks spread on BBO

• Trading outrights, calendar spreads, delta neutral, basis swaps. Roll starts before the options expiry (15th of preceding month). Active arbitrage versus USA (CME)

• 1 contract value as of today ~ 11,000 €

• Price Mechanism: The intervention price (floor price) managed by EU= 101 Euros/tonne

• Main uses: milling, starch, animal feed, food industry

• ADV in 2010 is 21k lots with ADV 31k lots in Aug 2010

• Reports: Weekly USDA (supply/demand and stocks) IGC, COCERAL

• Arb: CME – ((NYSE Liffe * EUR/$)/36.744)

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Milling Wheat Futures Contract Specification

Unit of Trading Fifty tonnes

Origins tenderable Milling Wheat from any EU origin

Quality Milling Wheat of sound, fair and merchantable quality. Discounts are applicable to the difference between standard and delivered quality

Delivery Months January, March, May, August, November such that eight delivery months are available for trading

Price Basis Euro and Euro cents per tonne in an approved public silo in Rouen, France

Min Price Movement

(Tick Value)

25 euro cents per tonne (€12.50)

Last Trading Day 18.30 on the tenth calendar day of the delivery month

Notice Day The first business day following the last trading day

Delivery Period Any business day from the last trading day to the end of the specified delivery month

Trading Hours 10.45-18.30 (Paris time)

Algorithm Price-time trading algorithm, with priority given to the first order at the best price

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Milling Wheat Futures: Volume and OI

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Milling Wheat Options: Volume and OI

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Milling Wheat Futures Settlement PriceFront Month Continuation Chart: Jan 08-Present

€/tonne

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Wheat Futures: CME & NYSE Liffe ($/bushel) Price $/bushel $/EUR

NYSE Liffe Milling Wheat Contract vs. CME Wheat Contract

How to Access the Markets

45

NYSE Liffe Commodities – Price Transparency

• Prices for all NYSE Liffe commodities can be found from major quote vendors, such as Bloomberg

46

NYSE Liffe Electronic Trading

ISVs*

Ffastfill

Trayport

GL Trade

Nyfix

RTS

Trading Technologies

Patsystems

Easyscreen

Direct Access Users (DAU)

LIFFE CONNECT®

Central Matching Engine

Trade registration system

ISV: Independent Software Vendor

47

Access Routes to NYSE Liffe

NYLNYL Clearing

Member

NYL Clearing Member

NYL Clearing Member

Client

NYL Non-Clearing Member

ISV

ISV

ISV

ClientNYL Clearing

Member

Broker

ISV

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Client a

Broker x

Broker/Exchange member

Client b

Broker y

Broker/Exchange member

Clearing house

Exchange

Role of Clearing House

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Cocoa Futures Contract Specification


Origins tenderable All origins tenderable. Discounts may apply for certain origins.

Quality Most cocoa is tenderable, subject to grading. Premiums apply for good quality; discounts for poorer quality.

Delivery Months March, May, July, September, December such that ten delivery months are available for trading

Price Basis Pounds sterling per tonne in an Exchange Nominated Warehouse in Europe

Min Price Movement

(Tick Value)

£1 per tonne (£10)

Last Trading Day Eleven business days immediately prior to the last business day of the delivery month at 12:00

Notice Day The business day immediately following the last trading day



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Cocoa Futures & Options Expiry Calendar

Delivery Month Futures Expiry Options Expiry

December 2010 14 December 2010 30 November 2010

March 2011 16 March 2011 28 February 2011

May 2011 13 May 2011 29 April 2011

July 2011 14 July 2011 30 June 2011

September 2011 15 September 2011 31 August 2011

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Robusta Coffee Futures Contract Specification


Origins tenderable Robusta coffee that from any Origin that is freely available for export to any destination

Quality Class 1 Robusta Coffee deliverable to Contract price (other qualities deliverable at set premiums and discounts)

Delivery Months January, March, May, July, September, November such that ten delivery months are available for trading

Price Basis US dollars per tonne in an Exchange Nominated Warehouse in Europe or the USA

Min Price Movement

(Tick Value)

$1 per tonne ($10)

Last Trading Day Last business day of the delivery month at 12:30

Notice Day Any business day during the delivery month



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Robusta Coffee Futures & Options Expiry Calendar


November 2010 30 November 2010 20 October 2010

January 2011 31 January 2011 15 December 2010


May 2011 31 May 2011 20 April 2011

July 2011 29 July 2011 15 June 2011

September 2011 30 September 2011 17 August 2011

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White Sugar Futures Contract Specification


Quality White beet, cane crystal sugar or refined sugar of the crop current at the time of delivery

Delivery Months March, May, August, October, December such that eight delivery months are available for trading

Price Basis US dollars and cents per tonne FOB and stowed in vessel’s hold in a designated port

Min Price Movement

(Tick Value)

10 cents per tonne ($5)

Last Trading Day Sixteen calendar days preceding the first day of the delivery month at 17:30

Tender Day Fifteen calendar days preceding the first day of the delivery period

Delivery Period The specified delivery month and the following month


Algorithm Price-time algorithm with priority given to first order at the best price

54

White Sugar Futures & Options Expiry Calendar


December 2010 15 November 2010 01 November 2010

March 2011 11 February 2011 01 February 2011

May 2011 15 April 2011 01 April 2011

August 2011 15 July 2011 01 July 2011

October 2011 15 September 2011 1 September 2011

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Milling Wheat Futures Contract Specification


Origins tenderable Milling Wheat from any EU origin

Quality Milling Wheat of sound, fair and merchantable quality. Discounts are applicable to the difference between standard and delivered quality

Delivery Months January, March, May, August, November such that eight delivery months are available for trading

Price Basis Euro and Euro cents per tonne in an approved public silo in Rouen, France

Min Price Movement

(Tick Value)

25 euro cents per tonne (€12.50)

Last Trading Day 18.30 on the tenth calendar day of the delivery month

Notice Day The first business day following the last trading day

Delivery Period Any business day from the last trading day to the end of the specified delivery month

Trading Hours 10.45-18.30 (Paris time)

Algorithm Price-time trading algorithm, with priority given to the first order at the best price

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Milling Wheat Futures & Options Expiry Calendar


November 2010 10 November 2010 15 October 2010

January 2011 10 January 2011 15 December 2010


May 2011 10 May 2011 15 April 2011

August 2011 10 August 2011 15 July 2011

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Contact Details

Aaron Gill Head of Business DevelopmentCommodity Derivatives, NYSE Liffe+44 (0) 207 379 [email protected]

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