Stops, limit orders and trading limits: a Safety Net for Futures Traders

Through the control offered by the exchanges, and government regulation, trading in the commodities markets does offer some limited protection from manipulation. The use of prudent orders does also offer some protection from loss. The Short Futures Position This simply means taking a short position in the hope that the futures price will go down. There is nothing to borrow and return when you take a short position since delivery, if it ever takes place, doesn't become an issue until some time in the future. Limit and Stop-Loss Orders "Limit orders" are common in the futures markets. In such cases, the customer instructs the broker to buy or sell only if the price of the contract he is holding, or wishes to hold, reaches a certain point. Limit orders are...

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Options on Futures

Options on futures began trading in 1983. Today, puts and calls on agricultural, metal, and financial (foreign currency, interest-rate and stock index) futures are traded by open outcry in designated pits. These options pits are usually located near those where the underlying futures trade. Many of the features that apply to stock options apply to futures options. An option's price, its premium, tracks the price of its underlying futures contract which, in turn, tracks the price of the underlying cash. Therefore, the March T-bond option premium tracks the March T-bond futures price. The December S&P 500 index option follows the December S&P 500 index futures. The May soybean option tracks the May soybean futures contract. Because option prices track futures prices, speculators can...

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Taking Delivery of Futures Contracts

You may wonder what happens if a trader forgets to close out a long position. If he bought live hog futures, will someone deliver 40,000 pounds worth of squealing porkers to his back door the morning after his contract expires? Sorry, but no. Brokerage firms watch their open accounts and know who has long or short positions in contracts nearing maturity. Prior to delivery day, they inform customers who have open long positions that they must either close out the position or prepare to take delivery and pay the full value of the underlying contract. By the same token traders with short positions are informed that they must close out their trades or prepare to deliver the underlying commodity. In this case, they must have the required quantity and quality of the deliverable...

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Keep in mind that futures prices are more volatile than stock prices

Hedging programs are used by individuals and companies who want protection against adverse price moves which would affect the cash commodities in which they deal. The Short Hedge In a short hedging program, futures are sold. This strategy is used by traders who either own the underlying commodity or are in some way subject to losses if its price declines. The Long Hedge Suppose the miller knows in July that in September he will buy 10,000 bushels of wheat from a grain elevator operator for grinding into flour. He worries that wheat prices will rise in the meantime because he has already guaranteed a price at which to sell flour to a baker in October. Because he does not have the wheat now, he is considered to be "short the actuals" or "short the cash market." Therefore,...

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Market News and Analysis

Keep in mind that futures prices are more volatile than stock prices. An established company that has enjoyed a long history of solid earnings will probably continue to do so. But a commodity that has trended up during one year, may turn around in the opposite direction the next year - and very quickly, too. For this reason, the commodity trader cannot sit back and relax knowing that his futures contract will bring in smooth returns. He must do his homework. In the futures market that means forecasting using fundamental analysis, technical analysis (charting), or both. Information Sources for Fundamental Analysis The fundamental approach to forecasting futures prices involves monitoring demand and supply. Traders gather this information from a number of sources trade organizations,...

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The Futures Clearing House

Each futures exchange has a clearing association which operates in conjunction with the exchange in a manner similar to a bank clearing house. Membership in the clearing association is composed exclusively of well-capitalized members of the exchange and corporations or partnerships one of whose officials must be an exchange member Exchange members who do not join the clearing association must clear their trades through a member of the association. Every clearing-house member must put up fixed original margins and maintain them with the clearing house in the event of adverse price fluctuations. In such instances, the clearing house may call for additional margins throughout the day without waiting for routine end-of-day settlement. It is worth noting here that parties to...

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Who Trades Futures and Why?

There are two basic categories of futures participants: hedgers and speculators. In general, hedgers use futures for protection against adverse future price movements in the underlying cash commodity. The rationale of hedging is based upon the demonstrated tendency of cash prices and futures values to move in tandem. Hedgers are very often businesses, or individuals, who at one point or another deal in the underlying cash commodity. Take, for instance, a major food processor who cans corn. If corn prices go up. he must pay the farmer or corn dealer more. For protection against higher corn prices, the processor can "hedge" his risk exposure by buying enough corn futures contracts to cover the amount of corn he expects to buy. Since cash and futures prices do tend...

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Futures Market Influences & Pressures

The cost of carry explains the basic relationship of cash to futures pricing, but it does not explain many less certain factors that can affect futures pricing such as seasonal influences and other unpredictable events. As for Interest-rate and currency futures - those based on T-bonds, T-bills, Eurodollars and the five major currencies - the biggest influences are the policies and trading activities of the Federal Reserve, U.S. Treasury and foreign central banks, all of which affect interest rates. Stock indexes are affected by whatever influences the stock market as a whole. Interest rates certainly play a major role - higher interest rates usually hurt the stock market. Other effects include the overall prospects for corporate earnings and corporate tax policies that help or hurt...

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What is a Futures Contract?

Unlike a stock, which represents equity in a company and can be held for a long time, if not indefinitely, futures contracts have finite lives. They are primarily used for hedging commodity price-fluctuation risks or for taking advantage of price movements, rather than for the buying or selling of the actual cash commodity. The word "contract" is used because a futures contract requires delivery of the commodity in a stated month in the future unless the contract is liquidated before it expires. The buyer of the futures contract (the party with a long position) agrees on a fixed purchase price to buy the underlying commodity (wheat, gold or T-bills, for example) from the seller at the expiration of the contract. The seller of the futures contract (the party with...

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Futures Exchanges - a look inside

Most exchange trading floors are divided into pits (or rings) where traders stand facing one another. These are more or less shallow octagonal areas with raised steps around the edge. Each pit is designated for trading one or more futures contracts. For instance, at the Chicago Board of Trade (CBOT) there are large pits for trading T-bonds, soybean, and corn futures among many others. The Commodities Exchange Center in New York houses more than one futures exchange. There you will find trading pits for such diverse commodities as coffee, sugar frozen orange juice, cocoa, gold, cotton, and heating oil. Every futures exchange is set up in about the same way. Like the stock exchanges, the people trading on the floor must be members of the exchange itself. The members support the...

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What is traded?

A cash commodity must meet three basic conditions to be successfully traded in the futures market: It has to be standardized and, for agricultural and industrial commodities, must be in a basic, raw, unprocessed state. There are futures contracts on wheat, but not on flour. Wheat is wheat (although different types of wheat have different futures contracts). The miller who needs a wheat futures to help him avoid losing money on his flour transactions with customers wouldn't need a flour futures. A given amount of wheat yields a given amount of flour and the cost of converting wheat to flour is fairly fixed. hence predictable. Perishable commodities must have an adequate shelf life, because delivery on a futures contract is deferred. The cash commodity's price must fluctuate...

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History of Futures Trading

In the 1840s, Chicago had become a commercial center with railroad and telegraph lines connecting it with the East. Around this same time, the McCormick reaper was invented which eventually lead to higher wheat production. Midwest farmers came to Chicago to sell their wheat to dealers who, in turn, shipped it all over the country. He brought his wheat to Chicago hoping to sell it at a good price. The city had few storage facilities and no established procedures either for weighing the grain or for grading it. In short, the farmer was often at the mercy of the dealer. 1848 saw the opening of a central place where farmers and dealers could meet to deal in "spot" grain - that is, to exchange cash for immediate delivery of wheat. The futures contract, as we know it today, evolved...

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