Introduction to Futures Trading


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This presentation is for use with PND's senior economics class unit on Futures trading.

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Introduction to Futures Trading

  1. 1. Introduction to Futures Trading Peoria Notre Dame High School
  2. 2. What is futures trading? <ul><li>Often described as the other market. </li></ul><ul><li>Futures contract is an agreed upon contract size and unit of measure for a set delivery date. </li></ul><ul><ul><li>Corn: 5,000 bushels </li></ul></ul><ul><ul><li>Soybeans: 5,000 bushels </li></ul></ul><ul><ul><li>Gold: 100 troy oz for December delivery </li></ul></ul><ul><ul><li>Coffee: 37,500 lbs or Arabica beans </li></ul></ul><ul><ul><li>Cocoa: 10 metric tons </li></ul></ul><ul><ul><li>Crude Oil: 100 barrells </li></ul></ul>
  3. 3. What commodities are traded? <ul><li>Agricultural </li></ul><ul><ul><li>Soybeans </li></ul></ul><ul><ul><li>Corn </li></ul></ul><ul><ul><li>Wheat </li></ul></ul><ul><ul><li>Soybean Oil </li></ul></ul><ul><ul><li>Soybean Meal </li></ul></ul><ul><ul><li>Grains </li></ul></ul><ul><li>Meat </li></ul><ul><ul><li>Live Cattle </li></ul></ul><ul><ul><li>Feeder Cattle </li></ul></ul><ul><ul><li>Live Hogs </li></ul></ul><ul><ul><li>Frozen Pork Bellies </li></ul></ul><ul><li>Currency </li></ul><ul><ul><li>All world currencies </li></ul></ul><ul><li>Softs </li></ul><ul><ul><li>Cocoa </li></ul></ul><ul><ul><li>Coffee </li></ul></ul><ul><ul><li>Sugar </li></ul></ul><ul><ul><li>FCOJ </li></ul></ul><ul><ul><li>Lumber </li></ul></ul><ul><ul><li>Cotton </li></ul></ul><ul><ul><li>Milk </li></ul></ul>
  4. 4. What commodities are traded? <ul><li>Financial Interest </li></ul><ul><ul><li>CanadianGovt Bonds </li></ul></ul><ul><ul><li>U.S. Treasury Bonds </li></ul></ul><ul><ul><li>U.S. Treasury Notes </li></ul></ul><ul><ul><li>Eurodollar </li></ul></ul><ul><li>Index </li></ul><ul><ul><li>Dax futures </li></ul></ul><ul><ul><li>CRB futures </li></ul></ul><ul><ul><li>DJIA futures </li></ul></ul><ul><ul><li>S&P futures </li></ul></ul><ul><ul><li>Russell 2000 </li></ul></ul><ul><ul><li>Nasdaq 100 </li></ul></ul><ul><ul><li>Nikkei 225 </li></ul></ul>
  5. 5. What commodities are traded? <ul><li>Metals </li></ul><ul><ul><li>Gold </li></ul></ul><ul><ul><li>Silver </li></ul></ul><ul><ul><li>Copper </li></ul></ul><ul><ul><li>Palladium </li></ul></ul><ul><ul><li>Platinum </li></ul></ul><ul><ul><li>Aluminum </li></ul></ul><ul><li>Others </li></ul><ul><ul><li>Canola </li></ul></ul><ul><ul><li>Flax Seed </li></ul></ul><ul><ul><li>Barley </li></ul></ul><ul><ul><li>Rubber </li></ul></ul><ul><ul><li>Lumber </li></ul></ul><ul><ul><li>Palm Oil </li></ul></ul>
  6. 6. Where are commodities traded? <ul><li>Traded at designated exchanges. </li></ul><ul><ul><li>CBOT, CME, NYBOT, NYMEX, SIMEX etc. </li></ul></ul><ul><li>Usually developed around where the industry was vital. </li></ul><ul><ul><li>Chicago as hub for grains, livestock, financial, index </li></ul></ul><ul><ul><li>New York for softs and metals </li></ul></ul><ul><li>Exchanges are located all over the world. </li></ul><ul><ul><li>Winnpeg, Sydney, Kansas, Minneapolis, Dubai, London, Sydney </li></ul></ul>
  7. 7. Who trades futures contracts? <ul><li>The Participants </li></ul><ul><ul><li>Numerous entities trade futures contracts. Large corporations need to hedge their risk. These are called hedgers. </li></ul></ul><ul><ul><li>Individuals or groups seeking to make a profit by accurately predicting price movement trade futures. Traders of this type are called speculators. Speculating or trading is different but related to the concept of investing. </li></ul></ul><ul><li>Why the pit or trading floor? </li></ul><ul><ul><li>All players in the world brought together. </li></ul></ul><ul><li>E-bay analogy </li></ul><ul><ul><li>E-bay is an electronic pit. All buyers and sellers converge at one place and the market price is esatblished. </li></ul></ul>
  8. 8. An Introduction to Hedging <ul><li>Hedging: a trade taken to reduce risk. </li></ul><ul><li>Example 1 – Airline and ticket price </li></ul><ul><ul><li>Southwest airlines needs to be able to offer ticket prices months in advance. One of the largest input costs is that of fuel. Fuel prices are dependent on crude oil. Southwest will hedge their fuel needs. A long futures position will allow Southwest to offset any loss in real cost associated with rise in fuel prices. </li></ul></ul><ul><li>Example 2 – Caterpillar and foreign sale </li></ul><ul><ul><li>Caterpillar sells $15 million worth of truck engines to a firm in South Africa. They intend to pay when delivered in the currency or Rand. Currency exchange rates fluctuate. Caterpillar will go long or short a corresponding amount of South African Rand futures to offset any potential losses by the dollar falling against the Rand. This allows Caterpillar to lock in a certain profit margin on the sale. </li></ul></ul>
  9. 9. Other Examples of Hedging <ul><li>Example 3 – Kellogg’s Cereal Company </li></ul><ul><ul><li>Kellogg needs to make all your favorite cereals. They will be purchasing large quantities of physical oats, corn, and wheat. A hedge in the futures market offsets risk due to changes in price. This leads to a stable price for consumers. </li></ul></ul>
  10. 10. Specific Example <ul><li>Bill Smith of Smith farms plants 2,000 acres of corn in March for harvest in December. At the time of planting the price of December corn at the CBOT is $4.00 a bushel. </li></ul><ul><li>With a yield of 200 bushels an acre Bill will have an estimated 400,000 bushels of corn. A contract is 5,000 bushels. Bill sells (goes short) 80 contracts of December corn at $4.00 each on the futures exchange. </li></ul><ul><li>In December the cost of corn has fallen to $3.50 a bushel. Bill has lost $0.50 a bushel on his physical corn or $200,000. </li></ul><ul><li>Bill’s hedge though is profitable He buys back his 80 contracts at $3.50. $4.00-$3.50 = .50 ($0.50 x 5,000 x80 = $200,000) </li></ul><ul><li>Bill’s hedge prevents him from losing $200,000 and locks in a profit margin. </li></ul>
  11. 11. The role of the speculator <ul><li>The Speculator </li></ul><ul><ul><li>The speculator who could be you, me, a pit trader, or a fund takes the other side hoping to profit from a change in market conditions. </li></ul></ul><ul><li>Overall benefit </li></ul><ul><ul><li>The benefit to the consumer in the end is price is accurate and reflects true supply and demand in the end. </li></ul></ul><ul><ul><li>Costs are saved due to the willingness of others to take personal risk for the opportunity of reward. </li></ul></ul>
  12. 12. Overall Structure of Markets <ul><li>Governance: </li></ul><ul><ul><li>The CFTC or Commodity Futures Trading Commission regulates the industry . </li></ul></ul><ul><ul><li>Various exchanges exist and govern themselves setting the rules for contract specifications. </li></ul></ul><ul><ul><li>5,000 bushels of grain, 11,200lbs of sugar, 18,750 lbs of coffee per contract. Amount that could fit in a box car. </li></ul></ul><ul><li>Clearing Firms and Brokers: </li></ul><ul><ul><li>Operate on Floor and execute trades on behalf of customers. </li></ul></ul><ul><li>Levels of Brokerage: </li></ul><ul><ul><li>Clearing firm, wholesale firm, Introducing Broker, retail customer. </li></ul></ul>
  13. 13. Others Involved <ul><li>Fund Managers </li></ul><ul><ul><li>Pool money of investors and trade it all together. Are compensated based off of performance. </li></ul></ul><ul><li>CTAs </li></ul><ul><ul><li>Often times act as an Introducing Broker and manage accounts for clients. Are compensated based off of performance and commission. </li></ul></ul><ul><ul><li>CTA means Commodity Trading Advisor </li></ul></ul><ul><ul><li>Licensed and registered with NFA after Series 7 exam. </li></ul></ul>