Introduction to Futures TradingPeoria Notre Dame High School

What is futures trading?

Often described as the other market.

Futures contract is an agreed upon contract size and unit of measure for a set delivery date. Corn: 5,000 bushels Soybeans: 5,000 bushels Gold: 100 troy oz for December delivery Coffee: 37,500 lbs or Arabica beans Cocoa: 10 metric tons Crude Oil: 100 barrells

What commodities are traded?

Agricultural Soybeans Corn Wheat Soybean Oil Soybean Meal Grains

Meat Live Cattle Feeder Cattle Live Hogs Frozen Pork Bellies

Currency All world currencies

Softs Cocoa Coffee Sugar FCOJ Lumber Cotton Milk

What commodities are traded?

Financial Interest CanadianGovt Bonds U.S. Treasury Bonds U.S. Treasury Notes Eurodollar

Index Dax futures CRB futures DJIA futures S&P futures Russell 2000 Nasdaq 100 Nikkei 225

What commodities are traded?

Metals Gold Silver Copper Palladium Platinum Aluminum

Others Canola Flax Seed Barley Rubber Lumber Palm Oil

Where are commodities traded?

Traded at designated exchanges. CBOT, CME, NYBOT, NYMEX, SIMEX etc.

Usually developed around where the industry was vital. Chicago as hub for grains, livestock,

financial, index New York for softs and metals

Exchanges are located all over the world. Winnpeg, Sydney, Kansas, Minneapolis,

Dubai, London, Sydney

Who trades futures contracts?

The Participants Numerous entities trade futures contracts. Large corporations need to

hedge their risk. These are called hedgers. Individuals or groups seeking to make a profit by accurately predicting

price movement trade futures. Traders of this type are called speculators. Speculating or trading is different but related to the concept of investing.

Why the pit or trading floor? All players in the world brought together.

E-bay analogy E-bay is an electronic pit. All buyers and sellers converge at one place and

the market price is esatblished.

An Introduction to Hedging

Hedging: a trade taken to reduce risk.

Example 1 – Airline and ticket price Southwest airlines needs to be able to offer ticket prices months in advance. One of

the largest input costs is that of fuel. Fuel prices are dependent on crude oil. Southwest will hedge their fuel needs. A long futures position will allow Southwest to offset any loss in real cost associated with rise in fuel prices.

Example 2 – Caterpillar and foreign sale Caterpillar sells $15 million worth of truck engines to a firm in South Africa. They

intend to pay when delivered in the currency or Rand. Currency exchange rates fluctuate. Caterpillar will go long or short a corresponding amount of South African Rand futures to offset any potential losses by the dollar falling against the Rand. This allows Caterpillar to lock in a certain profit margin on the sale.

Other Examples of Hedging

Example 3 – Kellogg’s Cereal Company Kellogg needs to make all your favorite cereals. They will be

purchasing large quantities of physical oats, corn, and wheat. A hedge in the futures market offsets risk due to changes in price. This leads to a stable price for consumers.

Specific Example

Bill Smith of Smith farms plants 2,000 acres of corn in March for harvest in December. At the time of planting the price of December corn at the CBOT is $4.00 a bushel.

With a yield of 200 bushels an acre Bill will have an estimated 400,000 bushels of corn. A contract is 5,000 bushels. Bill sells (goes short) 80 contracts of December corn at $4.00 each on the futures exchange.

In December the cost of corn has fallen to $3.50 a bushel. Bill has lost $0.50 a bushel on his physical corn or $200,000.

Bill’s hedge though is profitable He buys back his 80 contracts at $3.50. $4.00-$3.50 = .50 ($0.50 x 5,000 x80 = $200,000)

Bill’s hedge prevents him from losing $200,000 and locks in a profit margin.

The role of the speculator

The Speculator The speculator who could be you, me, a pit trader, or a fund

takes the other side hoping to profit from a change in market conditions.

Overall benefit The benefit to the consumer in the end is price is accurate and

reflects true supply and demand in the end. Costs are saved due to the willingness of others to take personal

risk for the opportunity of reward.

Overall Structure of Markets

Governance: The CFTC or Commodity Futures Trading Commission regulates the

industry . Various exchanges exist and govern themselves setting the rules for

contract specifications. 5,000 bushels of grain, 11,200lbs of sugar, 18,750 lbs of coffee per

contract. Amount that could fit in a box car.

Clearing Firms and Brokers: Operate on Floor and execute trades on behalf of customers.

Levels of Brokerage: Clearing firm, wholesale firm, Introducing Broker, retail customer.

Others Involved

Fund Managers Pool money of investors and trade it all together. Are

compensated based off of performance.

CTAs Often times act as an Introducing Broker and manage

accounts for clients. Are compensated based off of performance and commission.

CTA means Commodity Trading Advisor Licensed and registered with NFA after Series 7 exam.