Becoming Familiar
With the Futures
Market
• Section: Advanced Agribusiness
• Unit: Marketing
• Lesson Title: Becoming Familiar With the
Futures Market
Becoming Familiar With the
Futures Market
1.
2.
3.
4.
5.
6.
Define the futures market and its
functions and understand the functions
of the futures exchange.
Define a futures contract and
understand its standardized terms.
Describe the different futures market
participants.
Understand the clearing house and
margins.
Describe the difference between short
and long contracts.
Describe carrying charges.
Objective 1:
Defining the Futures Market
Objective 1: Defining the
Futures Market
• The Futures Market is defined as: The
process of trading futures contracts and
operating the facilities that market many
Ag products.
The Functions of the
Futures Market
Objective 1:
1. Provide an efficient and effective mechanism for the
management of price risk.
2. Provide an efficient mechanism for price discovery.
3. Provide a source of information for decision making.
4. Provide a means for firms to secure additional
operating capital.
The Functions of the
Futures Exchange
Objective 1:
1. To bring together in a central place a
large number of buyers and sellers.
2. To establish and enforce trading rules
and standards.
3. To settle disputes.
4. To collect and disseminate marketing
information to the public .
Objective 1:
• Define the futures market.
• Functions of the futures market.
• Functions of the futures exchange.
Objective 2
Define a futures contract
and understand its
standardized terms
Define a futures contract
o A legally binding commitment to make or take
delivery of a standardized quantity and quality of
a commodity at a predetermined place and time
in the future, for a price determined by auction in
the trading pit of an exchange
o Price is determined by open outcry.
o Open outcry is when bids are shouted in a pit.
o The benefit of open outcry is that it is competitive
price discovery.
Define A Futures Contract Cont.
There are two ways that a futures contract can
be settled.
o Delivery
o Less than 1% of all contracts traded is delivered
on.
o Offsetting.
o Means to do the opposite of what you had
previously done.
o Example: if you had previously bought a contract,
you sell it back. If you had sold one, then you
buy it back.
Standardized Terms
1.
2.
All terms for a futures contract are standardized, EXCEPT the
price.
1. The price again is found by open outcry in the trading pit.
The standardized terms include the following:
1.
2.
Delivery month –
1. month of contracts.
2. For example: March, May, July, September, December.
Contract Size –
1. Unit size of the contracts.
2. For Example: Grains are 5000bu; Feeder cattle are 50000lbs and
live cattle (fat Cattle) are 40000lbs
Standardized Terms Cont.
3. Place of delivery –
o
if delivered on the par delivery point.
4. Minimum Price fluctuations –
o
o
minimum movement in the price.
for example: ¼ cent in grains.
5. Maximum daily price move –
1. Maximum it can move in one day.
2. for example 30 cents in wheat.
Objective 2
• Define a Futures contract.
• Standardized Terms.
Think, Pair, Share
Objective #3
Describe the different futures
market participants
Objective 3:
Describe the different futures
market participants
1. There is a difference between traders and
brokers:
1. Traders
1. buy and sell contracts for him or her self –
does not take customer orders.
2. Brokers
1. take customers orders; may trade for him or
her self, but first responsibility is his
customer.
Objective 3:
Describe the different futures
market participants
1. We can classify the people who are the futures
market participants into several different
categories. The general public that trades would
be in the last two categories: either public
speculators or hedgers.
1. Floor brokers: fill orders for outside speculators and
hedgers.
2. Professional Speculators: trade for own accounts.
3. Scalpers – buys and sells minute by minute.
4. Pit traders – take larger positions and hold for longer,
but usually not overnight.
Objective 3:
Describe the different futures
market participants.
Floor traders – take large positions and hold for
several days.
6. Hedgers: Producers or users of commodities who
seek protection against adverse price changes by
taking a futures position opposite to cash position.
7. Public speculators: Place orders with brokers to
profit from anticipated price changes. Not
necessarily interested in owning the commodity, but
only in profiting off movements in the price.
5.
Objective 3
• Different Futures Market Participants.
– Traders, Brokers
• Floor Brokers
• Professional Speculator
• Scalper
• Pit Trader
• Floor Trader
• Hedgers
• Public Speculators
Objective 4
Understand the clearinghouse and
margins
Understand the
clearinghouse and margins
Objective 4:
• Clearing House
o Assumes the opposite side of every trade so that all
connections between buyers and sellers are served.
o Because the number of buys = number of sells, the
clearing house has no net position.
Objective 4:
Margins
1. To trade you must have an account.
2. With every new trade, traders must deposit money
called margin.
3. Margins serves as a deposit.
4. Initial margin: initial deposit paid.
5. Maintenance Margin: minimum amount of money that
must be kept in accounts.
6. Margins are NOT a COST for trading futures. Your
margin money is a deposit in your account and if your
trade is not a losing trade, you will still have your
margin money.
7. The clearing house “marks-to-market” all open
positions at the end of a day to adjust all accounts.
Objective 4: Margins Cont.
8. Margin Call – when the equity in the traders
account falls below the maintenance margin
level.
9. Must then deposit enough funds to bring the
equity in the account back to the initial margin
level.
Objective 4
• Clearinghouse
• Margins
Little Professor Moment
Teach to your partner
Objective 5:
Describe the difference between
short and long positions.
Objective 5: Short Position
The term to sell is also known as a short
position. To be short means that you are
trying to protect the commodity in your
possession from falling prices. Producers
are generally sellers of short position
holders.
Short = Sell = Protect from falling prices =
producer.
Objective 5: Long Position
• The term to buy is also known as a long
position. To be long means that you are
trying to protect the purchase price of a
commodity that you plan on obtaining
from rising prices. Mills, Factories, and
packers would be long position holders
• Long = Buy = protect from increasing
prices = Mills, factories, packers
Simple Rule:
•Buy Low and Sell
High in either order
Objective 5
• Short Position
• Long Position
• Simple Rule
Objective 6:
Describe carrying charges
Describe carrying charges
1. Carrying Charge = the difference in the
prices from one futures contract to
another.
Normal Market
1. Normal Market = is nearby price is lower than the
distant contract price – so prices increase into the
future. It reflects the cost of storage. For example,
if the nearby month is Dec and the Dec price is 2.32
and the March price 2.39 and the May price is 2.44
and the July Price is 2.48 and the Sept price is 2.57
then the market is normal.
2. Is common when supplies are large.
3. Tells the trader what the market will pay for storage.
4. Futures price spreads rarely reflect full carrying
charge.
Inverted Market
1. Inverted Market =
1.
2.
3.
nearby prices are higher than distant contract prices
– So prices decrease into the future.
It reflects a negative price of storage. In other
words, we are in short demand of the product so the
market price is telling you that they will pay a
premiums if the product is delivered now – do not
store the product until later.
For example, if Dec is the nearby month again, but
this time the Dec price is 2.32, the March price is
2.28, the May price is 2.20, the July price is 2.16,
and the Sept price is 2.10, now the market is
inverted.
Inverted Market Cont.
4. Usually prevails when supplies are small.
5. Market says they will pay a premium if you
deliver now.
6. Reflects negative price of storage.
Objective 6
• Carrying Charge
• Normal Market
• Inverted Market
Review and Summary
Now You Should Be Able To:
1.
2.
3.
4.
5.
6.
Define the futures market and its functions and
understand the functions of the futures
exchange.
Define a futures contract and understand its
standardized terms.
Describe the different futures market
participants.
Understand the clearing house and margins.
Describe the difference between short and long
contracts.
Describe carrying charges.
Any Questions
Quiz
1. Define the futures market.
2. What are the four main functions of a futures
market?
3. What are the four main functions of a futures
exchange?
4. What is a futures contract?
5. Price is determined by _______________
6. What is open Out cry?
7. What are the two ways a futures contract can be
settled?
Quiz
8. What are the 5 standardized terms of a futures
contract?
9. Who are the participants in the futures market?
10 What is a Clearinghouse?
11. What is the purpose of the clearinghouse?
12. What is a Margin?
13. What is a Maintenance Margin?
14. What is a Short Position?
15. Who is most likely to take a Short Position?
16. What is a Long Position?
Quiz
17. Who is most likely to take a Long
Position?
18. What is a normal market and give an
example of a Normal Market?
19. What is an Inverted Market and give an
example of such a market?
20. What is the simple rule to follow when
making trades on the futures market?