Download The Futures Market

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
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contract specifications
futures contract
futures market
stock markets
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What are futures markets?
What are the advantages and
disadvantages 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 and
disadvantages 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 and
disadvantages 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 and
disadvantages of futures trading?
B. Another market—the stock market—is 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 and
disadvantages 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 and
disadvantages of futures trading?
C. The advantages and disadvantages (cont’d)
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 the
contract 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 the
contract 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 the
contract 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 the
contract sizes of various commodities?
3. Today’s 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 the
contract 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 the
contract sizes of various commodities?
B. Contract sizes of various commodities
1. Live cattle futures—40,000 pounds equals one live
cattle futures contract.
2. Feeder cattle futures—50,000 pounds equals one
feeder cattle. futures contract
3. Lean hog futures—40,000 pounds equals one lean
hog futures contract.
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What items are specified on futures
contracts? What are the
contract sizes of various commodities?
B. Contract sizes of various commodities (cont’d)
4. Frozen pork bellies futures—40,000 pounds of frozen
pork bellies (cut and trimmed) equals one frozen pork
belly futures contract.
5. Corn futures—5,000 bushels (full-sized) and 1,000
bushels (mini-sized)
6. Wheat futures—5,000 bushels (full-sized) and 1,000
bushels (mini-sized)
7. Soybean futures—5,000 (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
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cash settlement
contract month
delivery point
demand
exchange clearinghouse
high
initial margin deposit
long
low
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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 (cont’d)
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 trader’s position and
makes certain there are sufficient funds available
to cover the trader’s obligations. Traders make an
initial margin deposit to ensure contract
performance. This deposit occurs at the beginning
of the trade. Trader’s 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 (cont’d)
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 (cont’d)
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 point—the 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 (cont’d)
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 (cont’d)
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 (cont’d)
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 8,000—regardless 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 (cont’d)
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 (cont’d)
c. The market price is where supply and demand meet.
It is, therefore, the product’s worth—considering
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.
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