Reasons for coop failure by r5uhfBp

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									Introduction to Futures Markets
  •   Overview
  •   Terms
  •   Participants
  •   Procedures
  •   Examples



                                  1
Cash or Spot Market
  •   The physical commodity
  •   “On the spot”
  •   At a specific location
  •   Price is established and commodity
      changes ownership


                                           2
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.




                                              3
Futures markets
• Biological nature of ag production
  • Excess supply at harvest
  • Shortage in spring and summer
  • Producers need price forecast because prices
    not known when production decision is
    made
  • Processors need year around supply


                                             4
Futures Market Exchanges
• Modern futures market began long ago
  • 1848 Chicago Board of Trade
  • 1898 Chicago Mercantile Exchange
  • 2007 CME Group merged CBOT and CME
• Highly regulated markets
  • Commodity Futures Trading Commission
    (CFTC)



                                           5
CME Group
 • http://www.cmegroup.com/
   • Products
     • Commodities and quotes
   • Education
     • Additional resources




                                6
Futures Market Exchanges
 • Centralized pricing
   • Buyers and sellers represented by brokers in
     the pits or electronically
   • All information represented through bids and
     offers
 • Perfectly competitive market
   • Open out-cry trading
   • Electronic trading

                                                7
Trading Futures Contracts
  • All trades through a licensed broker
  • Brokerage house has “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


                                                     8
Electronic trading: CME Globex
  • Customers must have a CME Clearing
    Firm relationship and a CME Group-
    certified trading application.
  • Individual investors are encouraged to
    connect through their broker, who can
    provide both the Clearing Firm
    guarantee and trading infrastructure.


                                             9
Futures contract
 • A futures contract is a commitment to make
   or take delivery of a specific quantity and
   quality of a given commodity at a specific
   delivery location and time in the future.
 • A legally binding contract
    • Trading the promise to do something in the
      future
    • You can “offset” your promise


                                               10
The futures contract
• All terms of the contract are standardized
  except for the price, which is discovered
  via the supply (offers) and the demand
  (bids).
• Standardized contract
   • Form (wt, grade, specifications)
   • Time (delivery date)
   • Place (delivery location)
                                           11
Standardized contract
  • Delivery months
  • Size of contract
    • Grains 5,000 bushels
       • Corn, Wheat, Soybeans
    • Livestock in pounds
       • Lean Hogs 40,000 lbs carcass
       • Live Cattle 40,000 lbs live
       • Feeder Cattle 50,000 lbs live
  • Specified delivery points
    • Relatively few delivery points
                                         12
The futures contract
 • No physical exchange takes place when the
   contract is traded.
 • Payment is based on the price established when
   the contract was initially traded.
 • Deliveries are made when the contract expires
   (delivery time).



                                              13
The futures contract
  • All contracts are ultimately settled through:
    • Liquidation by an offsetting transaction
    • Delivery of the actual physical commodity
  • Offset is most common
  • Delivery usually occurs in less than 2
    percent of all agricultural contracts traded.



                                                    14
Market participants
• Speculators have no use for the physical
  commodity.
  • They buy or sell in an attempt to profit from price
    movements.
  • Add liquidity to the market.
• May be part of the general public, professional
  traders or investment managers
  • Short-term – “day traders”
  • Long-term - buy or sell and hold
                                                          15
Market participants
• Hedgers are willing to make or take physical
  delivery because they are producers or users of
  commodity.
  • Use futures to protect against a price movement
  • Cash and futures prices are highly correlated
  • Hold counterbalancing positions in the two markets
    to manage the risk of price movement



                                                     16
Hedgers
•   Farmers, livestock producers
•   Merchandisers, elevators
•   Food processors, feed manufacturers
•   Exporters
•   Importers

• What happens if futures market is restricted to
  only hedgers?
                                                17
Market participants
• Brokers exercise trade for traders and are paid a
  flat fee called a commission.
• Futures are a “zero sum game”
  • Losers pay winners
  • Brokers always get paid commission




                                                  18
How futures markets work
 • Each trader opens an account with a licensed
   broker
 • The trader places an initial margin in the
   account for each contract traded
 • The amount of margin is set by the brokerage
   firm subject to minimum levels established
   by the exchange.


                                              19
How futures markets work
 • Margin is money that buyer or seller of
   futures contracts must deposit with a broker
   and the broker in turn must deposit with a
   clearing house.
 • The margin is the performance bond that
   ensures that all trades are honored.



                                                  20
How futures markets work
  • Trades of CME Group products, will clear
    through CME Clearing
  • At the settlement time each day every contract is
    settled.
  • The gain (loss) from the previous day is added
    (subtracted) to the trader’s margin account
  • If additional money is needed to comply with the
    margin requirements it is known as receiving a
    margin call.

                                                        21
How futures markets work
 • The clearing operation severs the connection
   between the original buyer and seller.
 • CME Clearing assumes the opposite side of
   each open position and thereby ensures the
   financial integrity of every futures and
   options contract traded at CME Group.
 • In turn, it holds each trader accountable by
   settling the margin account each day.
                                                  22
Market position
• Objective: Buy low, sell high
• You can either buy or sell initially to open a
  position
  • “Make” a promise
• Do the opposite to close the position at a later
  date
  • “Offset” the promise
  • Or make/take physical delivery of the commodity
    except for “cash settled” contracts
                                                   23
Speculator example:
• You believe that Asian Soybean Rust will
  reduce yields and that producers may plant
  fewer acres of soybeans to avoid potential
  Asian Rust problems.
• How can you profit from this scenario????




                                               24
Speculator example:
  • Pork producers have lost a record
    amount of equity and some will go out of
    business.
  • China lifted its restrictions related to
    H1N1 on U.S. pork imports.

  • How can you profit from this scenario?

                                             25
FUTURES: ACCOUNTING

• Margin (“performance bond”)
  • Money deposit to ensure fulfillment of a
    futures contract at a future date




                                               46
FUTURES: ACCOUNTING
• Margins
  • Initial margin
     • Deposit that must be made when opening a
       position

  • Maintenance margin
     • Minimum margin that must be maintained
       while holding an open position

  • Margin call
     • Call to deposit additional funds into margin
       account to bring it up to initial margin level
                                                        47
FUTURES: MARGINS
• Except for initial margin deposit,
  money not paid/received when
  futures are initially bought/sold.
• Margins
  • Different across commodities
  • Different for speculators vs. hedgers
  • May change over time


                                            48
Futures Margin per contract
                                Initial   Maintenance
  Corn            Speculator   $1,350          $1,000
  Corn            Hedger       $1,000          $1,000
  Soybeans        Speculator   $3,713          $2,750
  Soybeans        Hedger       $2,750          $2,750


  Lean Hogs       Speculator   $1,418          $1,050
  Lean Hogs       Hedger       $1,050          $1,050
  Feeder Cattle   Speculator   $1,350          $1,000
  Feeder Cattle   Hedger       $1,000          $1,000
  Live Cattle     Speculator   $1,080           $800
  Live Cattle     Hedger        $800            $800
                                                   49
January 4, 2010
Futures Summary
 • Today’s price for delivery in future
 • Standardized contract/promise to make or
   take delivery
 • Contract/promise can be offset
 • Several participants for different positions
 • Highly leveraged trade and must maintain
   margin account as a performance bond

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