Mechanics of Futures Market (1)

Dr. Michello

WHAT ARE FUTURES?

• Futures are contracts to buy or sell a specific commodity on a specific day for a present price.

WHY WERE THEY CREATED?

• Futures provide producers, farmers, and end users with the opportunity to hedge their position against large price swings and potentially large losses.

WHO TRADES FUTURES?

– Hedgers (Farmers and Commercials) trade futures to reduce risk.

• Example: Farmers who commit themselves to sell grain at a good price are protected if prices drop.

– Large Speculators (brokerage houses) trade both their own accounts and their client’s accounts to capitalize on price swings.

– Small Speculators (investors) trade futures to capitalize on large moves in the direction of their position.

TRADING FUTURES

• When you buy a futures contract, you pay an initial margin (usually between 2% and 10% depending on the client)

• This installment must remain 100% intact day to day. It can grow, but cannot drop.

• When you leave the market (i.e. sell it back) it cancels your obligation to buy the commodity on the contract expiration date.

MARKED TO MARKET

• Marked to Market means that at the end of the day, the house settles all accounts.

• If your contract profited on the day, the money is credited to your account when the market closes for the day. If the position went against you, the account is debited that amount.

TYPES OF COMMODITIES

SUBGROUPS

• Softs (Food and Fiber)• Grains and Oilseeds• Livestock• Metals

• Petroleum• Currencies• Index• Interest Rate

SOFTS

• Orange Juice

• Cocoa

• Coffee

• Sugar

• Cotton (fiber)

GRAINS and OILSEEDS

• Corn• Oats• Wheat

• Soybeans• Soybean Oil• Soybean Meal

LIVESTOCK

• Live Cattle

• Feeder Cattle

• Live Hogs

• Pork Bellies

METALS

• Copper

• Gold

• Silver

• Platinum

PETROLEUM

• Crude Oil

• Heating Oil

• Unleaded Gas

• Natural Gas

CURRENCIES

• British Pound

• Japanese Yen

• Swiss Franc

• Canadian Dollar

• Deutsche Mark

INDEX

• Dow Jones Industrial

• S&P 500

• Nasdaq 100

• US Dollar

• NYSE Composite

• Others

INTEREST RATE

• Treasury Bonds

• Treasury Notes– 2 yr. Notes– 5 yr. Notes

• Treasury Bills

• Municipal Bonds

• Eurodollar

OTHER COMMODITIES

• Lumber

• Palladium

• Milk

• Propane

• Butter

• Eggs

WHERE ARE FUTURES TRADED?

MAIN CITIES WITH EXCHANGES

• Chicago

• New York City

• Kansas City

• Minneapolis

CHICAGO EXCHANGES

• Chicago Board of Trade– Traded: grains, T-bonds and notes, metals, indexes

• Chicago Mercantile Exchange– Traded: livestock, currency, indexes

• MidAmerica Commodity Exchange (MidAm) deals in half contracts.– financial futures, currency, livestock, grain, metals

NEY YORK EXCHANGES

• CTN, NYFE, FINEX– New York Cotton exchange and its divisions

New York Futures exchange and Financial Instrument Exchange

• Traded: cotton, orange juice, currency, Treasuries, indexes

• CSCE– Coffee, Sugar, and Cocoa exchange

NY EXCHANGES (cont.)

• NYM, CMX-COMEX– New York Mercantile exchange and it’s

division Commodity exchange• Traded: Financial futures, metals

KANSAS CITY and MINNEAPOLIS EXCHANGES

• Kansas City Board of Trade– Traded: grains, livestock, softs

• MPLS– Minneapolis Grain Exchange

• These exchanges are mainly agricultural exchanges

CONTRACT SPECIFICATIONS

• These are the sizes of the contracts.

• Some examples:– 1 Wheat contract = 5,000 bushels of Wheat– 1 Gasoline contract = 42,000 gallons of Gas– 1 Sugar contract = 112,000 lbs. Of Sugar

• Therefore, if wheat is being traded at $3.20 a bushel, 1 contract = $16,000. A one cent move is equal to $50

SEAT PRICES

• A seat on the Chicago Mercantile Exchange today is worth between $385,000 and $400,000.

• A seat on the New York Mercantile Exchange is currently being offered by the exchange for $700,000.

JUST A NOTE

• Futures vs. Options– similarities

• Both Derivative investments (once or twice removed from an underlying product)

• Both were created to reduce risk

– difference• futures-obligation to buy/sell at a present price

• option-right to buy/sell at a preset price

IN CASE YOU’RE INTERESTED

• Here’s some web sites you can look at if you’re interested in learning more:– http://www.cbot.com– http://www.cme.com– http://www.nybot.com– http://www.nymex.com– http://www.kcbt.com– http://www.midam.com– http://www.cboe.com

QUESTIONS