Becoming Familiar With the Futures Market

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Becoming Familiar With the Futures Market

• Section Advanced Agribusiness
• Unit Marketing
• Lesson Title Becoming Familiar With the Futures
  Market

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Becoming Familiar With the Futures Market

1. Define the futures market and its functions and
   understand the functions of the futures exchange.
2. Define a futures contract and understand its
   standardized terms.
3. Describe the different futures market
   participants.
4. Understand the clearing house and margins.
5. Describe the difference between short and long
   contracts.
6. Describe carrying charges.

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Objective 1

• Defining the Futures Market

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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.

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Objective 1 The Functions of the Futures Market

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.

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Objective 1 The Functions of the Futures
Exchange

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 .

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Objective 1

• Define the futures market.
• Functions of the futures market.
• Functions of the futures exchange.

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Objective 2

• Define a futures contract and understand its
  standardized terms

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Define a futures contract

• 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
• Price is determined by open outcry.
• Open outcry is when bids are shouted in a pit.
• The benefit of open outcry is that it is
  competitive price discovery.

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Define A Futures Contract Cont.

• There are two ways that a futures contract can be
  settled.
• Delivery
• Less than 1 of all contracts traded is delivered
  on.
• Offsetting.
• Means to do the opposite of what you had
  previously done.
• Example if you had previously bought a contract,
  you sell it back. If you had sold one, then you
  buy it back.

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Standardized Terms

• All terms for a futures contract are
  standardized, EXCEPT the price.
• The price again is found by open outcry in the
  trading pit.
• The standardized terms include the following
• Delivery month
• month of contracts.
• For example March, May, July, September,
  December.
• Contract Size
• Unit size of the contracts.
• For Example Grains are 5000bu Feeder cattle
  are 50000lbs and live cattle (fat Cattle) are
  40000lbs

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Standardized Terms Cont.

• 3. Place of delivery
• if delivered on the par delivery point.
• 4. Minimum Price fluctuations
• minimum movement in the price.
• for example ¼ cent in grains.
• 5. Maximum daily price move
• Maximum it can move in one day.
• for example 30 cents in wheat.

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Objective 2

• Define a Futures contract.
• Standardized Terms.

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Think, Pair, Share
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Objective 3

• Describe the different futures market participants

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Objective 3 Describe the different futures
market participants

1. There is a difference between traders and
   brokers
2. Traders
3. buy and sell contracts for him or her self does
   not take customer orders.
4. Brokers
5. take customers orders may trade for him or her
   self, but first responsibility is his customer.

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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.
2. Floor brokers fill orders for outside
   speculators and hedgers.
3. Professional Speculators trade for own
   accounts.
4. Scalpers buys and sells minute by minute.
5. Pit traders take larger positions and hold for
   longer, but usually not overnight.

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Objective 3 Describe the different futures
market participants.

• 5. 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.

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Objective 3

• Different Futures Market Participants.
• Traders, Brokers
• Floor Brokers
• Professional Speculator
• Scalper
• Pit Trader
• Floor Trader
• Hedgers
• Public Speculators

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Objective 4

• Understand the clearinghouse and margins

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Objective 4 Understand the clearinghouse and
margins

• Clearing House
• Assumes the opposite side of every trade so that
  all connections between buyers and sellers are
  served.
• Because the number of buys number of sells, the
  clearing house has no net position.

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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.

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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.

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Objective 4

• Clearinghouse
• Margins

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Little Professor Moment

• Teach to your partner

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Objective 5

• Describe the difference between short and long
  positions.

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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.

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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

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Simple Rule

• Buy Low and Sell High in either order

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Objective 5

• Short Position
• Long Position
• Simple Rule

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Objective 6

• Describe carrying charges

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Describe carrying charges

1. Carrying Charge the difference in the prices
   from one futures contract to another.

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Normal Market

• 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.
• Is common when supplies are large.
• Tells the trader what the market will pay for
  storage.
• Futures price spreads rarely reflect full
  carrying charge.

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Inverted Market

• Inverted Market
• 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.

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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.

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Objective 6

• Carrying Charge
• Normal Market
• Inverted Market

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Review and Summary
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Now You Should Be Able To

1. Define the futures market and its functions and
   understand the functions of the futures exchange.
2. Define a futures contract and understand its
   standardized terms.
3. Describe the different futures market
   participants.
4. Understand the clearing house and margins.
5. Describe the difference between short and long
   contracts.
6. Describe carrying charges.

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Any Questions
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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?

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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?

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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?