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COMMODITIES FUTURES TRADING RISK MANAGEMENT Submitted by Darrell Boatright Modified by Georgia Agriculture Education Curriculum Office June 2007 HISTORY • Chicago Board of Trade established in 1848 by 82 merchants who were frustrated over unstable prices and neglected forward contracts. • Commodity futures contracts started being traded in 1865. • Chicago Mercantile Exchange was established in 1919. MARKET – Negotiable trade between a buyer and seller FUTURES EXCHANGE – A central market place with established rules and regulations where buyers and sellers meet to trade futures contracts. Cash Vs Futures Market Trading • In cash market, a physical commodity is exchanged in a buy and a sell agreement. • In futures market, you are paper trading and don’t take physical possession of the commodity in most cases. TWO TYPES OF FUTURES TRADERS • HEDGER - • an individual or company who offsets a cash market position by shifting some of the risk of adverse fluctuations in price, by buying or selling a futures contract. • Example: a farmer plants his corn crop in March and immediately sells a September futures corn contract. In the fall he harvests the corn and sells it on the cash market. He then buys back his September futures contract. He locks in his price and avoids market fluctuations. SPECULATOR • A market participant who tries to make a profit on buying or selling commodity futures contracts and assumes the majority of the risk from the hedger. • Example: a person expects cotton to rally because of heavy rains in the Mississippi delta will damage the crop and cause harvest delays. He buys a Dec contract of cotton and prays! BASIS • THE DIFFERENCE BETWEEN THE CASH MARKET PRICE AND THE FUTURES MARKET PRICE OF A COMMODITY. CONTRACTS • FUTURES ARE TRADED IN CERTAIN CONTRACT MONTHS • CONTRACTS ARE AT SPECIFIED AND PRE-DETERMINED AMOUNTS • OWNER DOESN’T TAKE PHYSICAL POSSESSION OF COMMODITY OPTION FUTURES CONTRACT • A futures contract in which you have the right but not an obligation to exercise your option at a future date. • Two types of option contracts: • Put - an option contract that gains value when the market price falls. •Call - an option contract that gains value when the market price rises. •Strike price - price you would like to receive for your commodity minus the premium.
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