Agribusiness Library

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Agribusiness Library
Lesson 060061 The Futures Market part 1
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Objectives

• 1. Describe the futures market, and examine the
  advantages and disadvantages of futures trading.
• 2. Identify the items specified on futures
  contracts, and determine the contract sizes of
  various commodities.

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Terms

• contract specifications
• futures contract
• futures market
• stock markets

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What are futures markets?
What are the advantages anddisadvantages of
futures trading?

• A futures market is a centralized market where
  buyers and sellers trade contracts of
  commodities. They are legally binding agreements
  to buy or sell something in the future. Nearly
  all futures contracts do not actually result in
  delivery of the basic commodity. Traders discover
  the advantages of the futures market by selling
  the contract or buying it back.

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What are futures markets?
What are the advantages anddisadvantages of
futures trading?

• The ultimate goal of buying futures contracts is
  to purchase at a certain price and sell the
  contract later at a higher price. Futures
  contracts are sold on the floor of a futures
  exchange.

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What are futures markets?
What are the advantages anddisadvantages of
futures trading?

• A. A futures contract is difficult to understand
  because it is not in writing like a cash
  contract. A futures contract is a verbal
  agreement between the buyer and seller made on
  the floor of an exchange that specifies the time
  of delivery, place of delivery, time of payment,
  and quality of the item.

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What are futures markets?
What are the advantages anddisadvantages of
futures trading?

• B. Another marketthe stock marketis a
  centralized market. However, it is completely
  different from the futures and cash markets.
  Futures markets trade contracts on commodities
  and financial products.
• Stock markets are markets that trade shares of
  ownership in publicly owned companies. When an
  individual buys stocks, he or she is buying
  shares of a company. When an individual buys
  futures, he or she is buying into a market that
  simply helps stabilize price as well as supply
  and demand fluctuations.

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What are futures markets?
What are the advantages anddisadvantages of
futures trading?

• C. The advantages and disadvantages of futures
  contracts are the following
• 1. Advantages
• a. They are easy to enter and exit.
• b. They minimize risk.
• c. They are often a better price than
  a forward
  contract.

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What are futures markets?
What are the advantages anddisadvantages of
futures trading?

• C. The advantages and disadvantages (contd)
• 2. Disadvantages
• a. There is no benefit from better prices.
• b. There is a commission cost.
• c. There are margin calls.
• d. There are set quantities.

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What items are specified on futures contracts?
What are thecontract sizes of various
commodities?

• Items specified on futures contracts and contract
  sizes of commodities
• A. The standard features that specify all the
  standard details of the contract are contract
  specifications. The specifications can be
  found in the local paper with the daily
  prices or by contacting the exchange where
  the commodity is traded.

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What items are specified on futures contracts?
What are thecontract sizes of various
commodities?

• 1. A futures contract contains specific
  information about the commodity and is a
  standardized agreement to buy or sell a
  commodity at a date in the future.

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What items are specified on futures contracts?
What are thecontract sizes of various
commodities?

• 2. Traditionally, a futures contract would
  specify
• a. The types of commodity to be delivered (e.g.,
  corn, soybeans, wheat, or live cattle)
• b. The quantity of the commodity (e.g., number
  of bushels of grain or pounds of livestock)
• c. The quality of the commodity (e.g., specific
  U.S. grade)
• d. The delivery point
• e. The delivery date

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What items are specified on futures contracts?
What are thecontract sizes of various
commodities?

• 3. Todays contract specifications
• a. For cattle and hogs the trade unit, point
  descriptions, contract listing, trading venue,
  product code, hours, listed, strike, limits,
  and minimum fluctuation
• b. For grain and oilseed futures contract size,
  deliverable grades, price quote, tick size,
  contract months, last trading day, last
  delivery day, trading hours, ticker symbols,
  and daily price limit

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What items are specified on futures contracts?
What are thecontract sizes of various
commodities?

• 4. The only part of a futures contract that is
  not specified is price. The price varies and is
  determined on the floor during commodity
  exchanges by traders who buy and sell the
  contracts.

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What items are specified on futures contracts?
What are thecontract sizes of various
commodities?

• B. Contract sizes of various commodities
• 1. Live cattle futures40,000 pounds equals one
  live cattle futures contract.
• 2. Feeder cattle futures50,000 pounds equals
  one feeder cattle. futures contract
• 3. Lean hog futures40,000 pounds equals one
  lean hog futures contract.

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What items are specified on futures contracts?
What are thecontract sizes of various
commodities?

• B. Contract sizes of various commodities (contd)
• 4. Frozen pork bellies futures40,000 pounds of
  frozen pork bellies (cut and trimmed) equals
  one frozen pork belly futures contract.
• 5. Corn futures5,000 bushels (full-sized) and
  1,000 bushels (mini-sized)
• 6. Wheat futures5,000 bushels (full-sized) and
  1,000 bushels (mini-sized)
• 7. Soybean futures5,000 (full-sized) and 1,000
  bushels (mini-sized)

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Review

• How does the stock market differ from futures and
  cash markets?
• Name some advantages and disadvantages of futures
  markets.
• What do the futures contracts typically specify?

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Agribusiness Library
Lesson 060061 The Futures Market part 2
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Objectives

• 3. Explain the process of buying and selling
  futures.
• 4. Explain how to read commodity prices, and
  determine how futures market prices can change.

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Terms

• cash settlement
• contract month
• delivery point
• demand
• exchange clearinghouse
• high
• initial margin deposit
• long
• low

• market price
• net change
• offset
• open
• open interest
• settle
• short
• supply
• volume

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What occurs during the buying and selling of
futures?

• People buy and sell to achieve a profit.
  Sometimes the sale is profitable sometimes it is
  not. The laws of supply and demand usually
  determine prices. A futures contract acts as an
  agreement between the buyer and seller it
  specifies the quantity and quality of a
  commodity. It is not the definite buying and
  selling of a physical commodity.

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What occurs during the buying and selling of
futures?

• A. The goal of buying and selling is to buy at a
  price and sell later at a higher price. For
  example, if someone buys a bushel of corn for
  2 one day, he or she hopes the price will get
  higher so the corn can be sold for more than 2
  at a later date. This does not always happen.
  Sometimes the price of the corn will decrease,
  causing the person to lose money when he or she
  sells it to someone else for less than 2.

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What occurs during the buying and selling of
futures?

• B. Being short or being long a particular
  contract
• 1. The initial sell in the futures market is
  called a short. If a trader sells a futures
  contract, he or she is often referred to as
  being short that particular contract.

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What occurs during the buying and selling of
futures?

• 2. The initial buy or the physical ownership is
  called a long in the futures market. If a
  trader buys a futures contract, he or she is
  often referred to as being long that particular
  contract.
• a. If someone buys or is said to be long and
  then later sells, he or she has offset (taken
  the opposite action) to get out of an initial
  futures or option contract. An individual would
  do this if he or she thought it would be
  possible to sell corn now for 2 and buy it back
  later for less than 2.

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What occurs during the buying and selling of
futures?

• 2. The initial buy or the physical ownership is
  called a long (contd)
• b. In the futures market, it is difficult to
  understand that a person can sell a contract
  for something that he or she does not actually
  own. However, it is like entering an obligation
  or promise to do something in the future.

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What occurs during the buying and selling of
futures?

• C. The exchange clearinghouse is an institution
  that tracks the value of each traders position
  and makes certain there are sufficient funds
  available to cover the traders obligations.
  Traders make an initial margin deposit to ensure
  contract performance. This deposit occurs at
  the beginning of the trade. Traders margin
  money is secured and maintained in an account
  and is adjusted daily to show a gain or loss in
  contract value.

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What occurs during the buying and selling of
futures?

• D. The price of an item is usually determined by
  supply and demand.
• 1. Supply is the quantity of a product or
  service that sellers are willing or able to
  provide to the market at a given price.
• 2. Demand is the quantity of a product or
  service buyers are willing and able to purchase
  from the market at a given price.

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What occurs during the buying and selling of
futures?

• D. The price of an item (contd)
• 3. Many different things affect supply and
  demand.
• a. The supply of corn could be affected by the
  cost of production, weather throughout the
  world, prices of related products, and the
  number of sellers in the market.
• b. The demand of corn could be affected by a
  change in income of consumers, the number of
  buyers, the prices of related items, and the
  time of year.

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What occurs during the buying and selling of
futures?

• E. When buying a futures contract, a person is
  promising to accept or deliver a physical
  product in the future. Many commodity markets do
  not have contracts for every month because of
  biological and technical conditions of the
  commodity.
• 1. The contract month stated on the contract is
  the month in the future when the purchaser is
  accepting or delivering a product. One of two
  things must happen before the contract expires.

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What occurs during the buying and selling of
futures?

• 1. The contract month (contd)
• a. The person can accept delivery of the item
  specified in the contract when the contract
  expires.
• b. The person can sell an identical futures
  contract or offset the contract before it
  expires. (Only about 5 of the traded contracts
  are actually delivered.)

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What occurs during the buying and selling of
futures?

• 2. If a person is concerned about having 5,000
  bushels of corn dumped in his or her driveway,
  he or she should look at the delivery pointthe
  designated place where the commodity must be
  moved to satisfy the terms of the delivery. This
  location is stated on a delivery notice, stating
  where the delivery will be if it takes place.

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What occurs during the buying and selling of
futures?

• 3. Physical delivery is avoided all together by
  cash settlements. A cash settlement is the
  process of discharging or offsetting a futures
  contract that has expired. Calculating the
  difference between the final futures price and a
  final cash price offsets the futures obligation.
  Therefore, the buyer and seller agree to close
  their positions and trade in cash rather than
  physically exchanging a commodity.

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How can commodity prices be
interpreted?
How do futures market prices change?

• Futures market trading has limited price
  movements for most products, so there is usually
  not a large increase or decrease from day to day.
• A. The futures market
• 1. Volume is the number of total contracts
  traded.
• 2. Open interest is a measure of contracts that
  have not been offset by a buy and then a sell
  (or vice versa).

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How can commodity prices be
interpreted?
How do futures market prices change?

• A. The futures market (contd)
• 3. Profit or loss is calculated based on the
  difference in the sell and buy prices at the
  times when the contract was sold or bought. In
  the futures market, there must be a buy for
  every sell and a sell for every buy.
• 4. Even though the contracts are simply a
  promise to deliver or accept, there is a
  physical commodity behind every contract.

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How can commodity prices be
interpreted?
How do futures market prices change?

• B. Futures prices can be found in many
  newspapers, on television business reports, and
  on the Internet. Some terms are essential in
  understanding the numbers listed.
• 1. Open is the first price anyone paid for
  the specific futures on the given date.
• 2. High is the highest price anyone paid
  during trading on the given date.
• 3. Low is the lowest price anyone paid
  during trading on the given date.

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How can commodity prices be
interpreted?
How do futures market prices change?

• B. Futures prices (contd)
• 4. Settle is the last price that anyone paid
  during trading on the given date.
• 5. The net change is the difference between the
  last price anyone paid during trading on the
  given date and the previous trading day. It is
  important for an individual to monitor the
  daily prices so he or she can offset his or her
  position before the contract expires.
  Otherwise, the individual will have to deliver
  or accept delivery of the product.

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How can commodity prices be
interpreted?
How do futures market prices change?

• C. The price of commodities changes with an
  increase or decrease in supply and demand. How
  much is being produced and how much is being
  consumed are the greatest factors in determining
  commodity prices.

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How can commodity prices be
interpreted?
How do futures market prices change?

• 1. Supply (how much of something there is for
  sale) can be influenced in many ways. For
  instance, a corn supply could be affected by
• a. Production costs
• b. Price increases for equipment, fertilizer,
  gasoline, or any other input
• c. The price of related goods
• d. The number of sellers in the market
• e. The future expectation of prices

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How can commodity prices be
interpreted?
How do futures market prices change?

• 2. Demand (how much of something people are
  willing to buy at a given price) is also
  influenced by many factors.
• a. A change in personal income
• b. The price of related goods

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How can commodity prices be
interpreted?
How do futures market prices change?

• 3. The relationship between supply and demand
  come together to create a price.
• a. Supply increases if people are willing and
  able to supply more of a product or service at
  every price. For example, supply would increase
  if farmers were willing to produce 8,000 pounds
  of milk every day if the price was 2 per
  hundred or 20 per hundred. It would increase
  because no one is producing less even though
  the price is different. Demand increases if
  people are willing and able to buy more of a
  product or service at every price.

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How can commodity prices be
interpreted?
How do futures market prices change?

• 3. The relationship between supply and demand
  (contd)
• b. Supply decreases if people are willing and
  able to supply less at every price. The supply
  would decrease if farmers produced 4,000 pounds
  of milk every day compared to 8,000regardless
  of the price. Demand decreases if people are
  willing and able to buy less at every price.

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How can commodity prices be
interpreted?
How do futures market prices change?

• 3. The relationship between supply and demand
  (contd)
• b. For instance, if consumers all bought 10
  flats of flowers at 5 each or 15 each, the
  demand would increase because they are buying
  regardless of price. On the other hand, if
  people buy five flats of flowers each at
  different prices, the demand will decrease
  because fewer flowers are being bought overall.

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How can commodity prices be
interpreted?
How do futures market prices change?

• 3. The relationship between supply and demand
  (contd)
• c. The market price is where supply and demand
  meet. It is, therefore, the products
  worthconsidering supply and demand factors.

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Review

• Describe being short or being long a particular
  contract.
• Name some factors that affect supply and demand.
• Why do traders make an initial margin deposit?
• Name three place you can find futures prices.