Basic Futures Definitions

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ECON 337:
Agricultural Marketing
Lee Schulz
Assistant Professor
[email protected]
515-294-3356
Chad Hart
Associate Professor
[email protected]
515-294-9911
Futures Markets
Organized and centralized market
Today’s price for products to be delivered
in the future
A mechanism of trading promises of future
commodity deliveries among traders
Futures and Options
Market tools to help manage (share) price
risks
Mechanisms to establish commodity
trades among participants at a future time
Available from commodity exchanges /
futures markets
Agricultural Futures Markets
Has some unique features due to the nature of agricultural
businesses
Supply comes online a few times during the year
So at harvest, supply spikes, then diminishes until the
next harvest
Production decisions are based price forecasts
Planting decisions can be made a full year (or more)
before the crop price is realized
Users provide year-round demand
Livestock feeding, biofuel production, food demand
Futures Market Exchanges
Competitive markets
Open out-cry and electronic trading
Centralized pricing
Buyers and sellers are both in the market
Relevant information is conveyed through the bids
and offers for the trades
Bid = the price at which a trader would buy the
commodity
Offer = the price at which a trader would sell the
commodity
CME Group
http://www.cmegroup.com/
Products
Agricultural commodities
Corn, soy, cattle, hogs, etc.
Energy
Currency
Metals
Weather
Others
Futures Contracts
A legally binding contract to make or take
delivery of the commodity
Trading the promise to do something in the
future
You can “offset” your promise
Standardized contract
Form (weight, grade, specifications)
Time (delivery date)
Place (delivery location)
Soybean Futures
Form
5,000 bushels
No. 2 Yellow Soybeans (at price), No. 1
Yellow soybeans (at 6 cents over price), and
No. 3 Yellow Soybeans (at 6 cents under
price)
Time
Contract months: Sept, Nov, Jan, Mar, May,
July, and August
Source: CME Group
Soybean Futures
Partial listing of delivery points
Source: CME Group Rulebook
Delivery Points
Corn
Soybeans
Wheat
Source: Irwin, Garcia, Good, and Kunda, 2009
Marketing and Outlook Research Report 2009-02
Futures Contracts
 No physical exchange takes place when the
contract is traded (no actual commodity moves)
 Payment is based on the price established when
the contract was initially traded (prices can and
will change before delivery is taken)
 Deliveries can be made when the contract
expires or the offsetting futures position must be
taken to settle up
 Deliveries occur on less than 5 percent of the traded
contracts
Market Positions
You can either buy or sell initially to open a
position in the futures market
“Make” a promise to make or take delivery
Do the opposite to close the position at a
later date
“Offset” the promise (and no commodity changes
hands)
Trader may also hold the position until
expiration and make or take physical delivery
of the commodity
Trading Futures Contracts
All trades through a licensed broker
Brokerage house has a “seat” at the
exchange and is allowed to trade
Represented “on the floor” to exercise trade
Local broker to initiate transaction and
manage account with client
Full service and discount brokers
CME Group
http://www.cmegroup.com/
Open, High, Low, Last Price
Settlement Price
Volume
Open Interest
Daily Limits
Terms and Definitions
Basis
The difference between the spot or cash
price and the futures price of the same or a
related commodity.
Bear
Someone that thinks the price will decline
Bull
Someone that thinks the price will increase
Cash vs. Futures Prices
Iowa Corn in 2013
The gap between the
lines is the basis.
2013 Basis for Iowa Corn
Terms and Definitions
Clearing House
The division of the futures exchange through
which all trades made must be confirmed,
matched and settled each day until offset or
delivered.
Commission
For futures contracts, the one-time fee
charged by a broker to cover the trades you
make to open and close each position.
Terms and Definitions
Long position
A position in which the trader has bought a
futures contract that does not offset a
previously established short position.
Short position
A position in which the trader has sold a
futures contract that does not offset a
previously established long position.
Going Short
Sold Dec. 2014 Corn @ $4.55
What type of trader (bull or bear) would go short?
What events would send prices in a favorable direction?
Going Long
What type of trader (bull or bear) would go long?
Bought Nov. 2014 Soybeans @ $11.20
What events would send prices in a favorable direction?
Class web site:
http://www.econ.iastate.edu/~chart/Classes/econ337/
Spring2014/
Have a great weekend!
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