Futures Marketing Section II Mechanics of Futures Trading

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Futures MarketingSection II Mechanics of
Futures Trading
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Price Discovery

• Buyers and sellers interacting with information
  to arrive at a price through negotiation.

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Futures Market Price

• A source of what buyers and sellers think a
  commodities worth, at some point in the future,
  today.

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Futures Contract

• A transferable agreement to make or take delivery
  of a standardized amount of a commodity of
  minimum quality during a specific month.
• Every contract identical except for price.

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Terms of a contract

• Commodity
• Price
• Quantity
• Quality
• Time of Delivery
• Place of Delivery
• Terms of Payment

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Additional Terms Related to the Futures Contract

• Price Quotations and Price Fluctuations
• Maximum Daily Price Change (limit move)
• Volume of Trade
• End of Delivery Month Trading Suspension
• Bearish
• Bullish

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Delivery Months Basis for Selection

• Natural Climatic Months
• Concentration of Volume of Trading
• Inertia

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Settlement of a Futures Contract

• Delivery
• Short - make delivery Long take delivery
• Offsetting Transaction
• Reversing position with offsetting contract, if
  you were short in the market you would buy a
  contract.

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Mechanics of Delivery

• NOI Notice of Intent to deliver short position
• First Notice Day Sent by short position to
  oldest long position
• Delivery Day-
• Retendering-

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Functions of the Clearing House

• Reconciliation of all futures contracts
• Assuring the financial integrity of all
  transactions

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Characteristics of Clearing House

• Separate from exchange
• Membership is very limited, must be members of
  the exchange
• Requirements for membership are stringent
• Stock Corporation
• Members must deposit substantial money

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Notice of Intent Scenario
short
LS
LS
LS
L
A B C D E
Clearing House
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Concept of Long and Short
Long ------------- Buy
Short -------------Sell
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Open Interest

• 1 long 1 short

1 open contract
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Open Interest Example
A sells to B
A- Short B- Long
C sells to B
A- Short B-Long 2 contracts C- Short
Open Interest 2 Volume 4
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Volume and Open Interest CBOTNovember Soybeans
as of Friday
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Volume and Open Interest CBOTJanuary Soybeans as
of Friday
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Selecting a Brokerage House

• Broker with Experience
• Knowledge of Commodity
• Convenience
• Willingness to Service Account

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Purpose of Margin

• Secure Position of Trader
• Solvency of Clearing House
• They take opposite sides of transaction

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Margin Accounts

• Separate for each customer
• Audited frequently see if posted properly and
  not being used
• Commission House cannot use money
• Amount can vary from one brokerage house to
  another
• Does not pay interest

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Initial Margin amount you must post at
origination of contract

• Sell Contract post 3,000 margin for soybeans.
  (5 to 15 of contract)
• What happens if price goes up?
• Contract Losing Money
• Effective Margin has been eroded.
• When the EM reaches the call point you must post
  new margin money to bring you account back to the
  original level of margin.

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Example -- Margin Call

• Sell November Soybeans at 7.00 must post margin
  of 10 of contract value.
• Post Margin of 10 of (7 5,000 bushels)
• Margin posted 3,500, call point is 2,000
• If price increases to 7.40 what is the effective
  margin?
• EM 1,500, EM lt Call Point must post new margin
  monies.