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A futures contract is an obligation to buy or sell a commodity at some time in the future, at a price agreed upon today.
The contracts themselves are interchangeable. They are standardized as to terms such as the grade of commodity that is acceptable and when and where it can be delivered. The word commodity is defined very broadly to include physical commodities, financial instruments, forex and stock indexes. The contracts are traded on an organized and regulated futures exchange so that buyers and sellers can easily find each other. The exchange clearinghouse is the counterparty to every trade, which not only reduces credit risk in futures trading but also makes it easy for position holders to exit at any time they wish.
Futures vs. Options.
Newcomers to futures trading often confuse futures trading with equity options trading. But, they definitely are different investing approaches. The only similarity between a futures contract and an options contract is that they both have an expiration date. But a futures contract is not a wasting asset like an option contract.
Futures markets exist for the purposes of price discovery and the transference of risk. They can provide an excellent way to express your own opinion about where prices are heading. So if an option is a four-dimensional instrument, then a futures is simply a two-dimensional instrument. But they are very different from options.
An options contract conveys the right, not the obligation, to assume a position in the underlying instrument at a specific (strike) price any time before the option expires. When you buy (go long) an option, your risk is limited to the premium you pay. The cost of the option is known as a premium (similar to insurance) and is based on time, volatility and the relative value of your strike price to the underlying market.
However, the value of a futures contract is ultimately tied to the underlying product or instrument (e.g., S&P 500 Index, gold, crude oil, U.S. Treasury bonds or notes, soybeans, etc.) via each contract's specifications. You can either buy (go long) or sell (go short) any futures contract and your risk (or potential profit) is virtually unlimited.
However, what you know about option trading may be extremely useful when you enter the futures trading world. That’s because futures exchanges also list options on futures contracts. Just as in equities, you can take an options position that defines your risk on a position that has a futures contract as the underlying instrument.
Initial Margin vs. Maintenance Margin.
Initial margin is the amount of funds that you must deposit when the positions are initially put on. Maintenance margin is the minimum balance that must be maintained in a trading account to keep positions.
Don't make the common beginner's mistake of trying to add the two numbers together. Rather, think of maintenance margin as a subset of initial margin.
Maintenance margin is usually a smaller number than initial margin and really doesn't come into play unless the account balance is shrinking due to losses. If the value of the account balance falls below maintenance level then you're required to get the account back into compliance (a margin call). You can do this by either sending more money (raising the balance back up to initial margin) or lightening up your position (lowering the initial margin back down to the balance).
Futures Contract Contract Value Initial Margin Maintenance Margin.
Notice that maintenance margin is usually a smaller number than initial margin. In the case of the E-Mini S&P futures contract, you'll need at least $5,625 (initial margin) in your account to buy or sell a single contract. To trade 10 contracts you'd need $56,250 (10 x $5,625).
If the value of your account balance falls below $4,500 per contract (maintenance margin), you'll get a margin call requiring that you bring your balance back to at least $5,625 times the number of contracts you hold. Or, you can choose to offset all or part of the position.
What Is Contract Value?
Futures Trading Account Value.
All futures contracts are settled daily and assigned a final value price. Based on this settlement price, the value of all positions are "marked-to-the-market" each day after the official close; your account is either debited or credited based on how well your positions fared in that day's trading session. As long as your position(s) remains open, cash will either come into your account or leave your account based on the change in the settlement price from day to day.
This system gives futures trading a rock-solid reputation for credit-worthiness because losses are not allowed to accumulate without some response being required. It is this mechanism that brings integrity to the marketplace.
Or considered another way, every trader can have confidence knowing that the other side of his trade will be made good. Clearing member firms at the clearinghouse, and ultimately the Financial Safeguards by CME Clearing.
Guide to margins & order entry.
Margins – A Basic Introduction.
Initial margin is the amount of money required to open a derivatives position, whether in FOREX, CFD’s or Futures. It is in effect a security deposit to ensure that traders have sufficient funds to meet any potential loss from a trade. When a position is closed out or settled money deposited by way of margin is returned, plus or minus any resulting profit or loss.
If a position involves an exchange – traded product, the amount or percentage of initial margin is set by the exchange/ clearing concerned. However, bank or brokerage firms often require a larger amount of margin than that set by the exchange. In times of market volatility margin requirements can change quickly.
If a position is making a loss and the value of the initial margin is being eroded, the broker will make a margin call in order to restore the amount of initial margin available. Often referred to as “variation margin”, margin call for this reason is usually done on a daily basis, however, in times of high volatility a broker can make a margin call or calls intra-day.
Calls for margin are usually expected to be paid and received on the same day. If not, the broker has the right to close sufficient positions to meet the amount called by way of margin. After the position is closed-out the client is liable for any resulting deficit in the client’s account.
Exchanges have the term “maintenance margin”, which in effect defines by how much the value of the initial margin can reduce before a margin call is made. However, many European brokers only use the term “initial margin” and “variation margin”.
Consider the example below:
A CME Group traded COMEX Gold futures contract (GC) of 100 troy ounces with an initial margin of $4400 with a maintenance margin of $4000:
Day 1 A client lodges $4400 initial margin and buys an August gold future (GC) at a price of $1200 per ounce. (every $1 movement in the price of gold generates a profit or loss of $100)
Gold closes the day at $1195.00, which means the client is losing $500.
Day 2. The broker makes a margin call for $500 up to the initial margin level and expects to receive funds on the same day.
The client pays his margin call and on day 2 gold closes at $1198. In this case the client now has $300 surplus in his futures trading account The client does not pay his margin call and on 3rd day the broker sells out the contract at 1190. The client is debited $1000 and now has a balance of $3400 The client does not pay his margin call but promises to meet the call on 3rd day. The broker uses his discretion to give the client an extra day to pay. On day 4 the price drops to $1150 and no margin has been received. The broker closes out the trade creating a loss of $5000. The client is now left with a $600 deficit in his futures trading account (i.e. initial margin $4400 less loss of $5000) for which he is legally liable to pay.
The process of placing Futures orders.
Before considering specific types of orders, it is valuable to understand the general procedure:
Call the trading desk direct. Renesource Capital brokers are there to deal with Client calls. Your very first step will be to identify yourself using your unique client code, voice trading password, account number and name. Pass your order. This will help ensure that you will be more confident in what you are saying and be able to provide all the correct information in the right order. Renesource Capital broker will then repeat your order back and ask you if this is correct. Although all of our Brokers are professionally trained to deal with novice/ beginners and expert customers there is the chance that they may speak more quickly than you are prepared for. If you are unsure that the details are correct, ask for it to be repeated, more slowly. Only when you are satisfied that the order has been repeated correctly, should you say it is correct. The order is then transmitted to either the floor or an electronic exchange. If it is a market order (i.e. you want to trade NOW), then under normal circumstances, you may hold whilst the Broker places the order in the exchange trading system. You receive the fill price (the best price we have managed to obtain in the market) from your Broker. If however, it is another kind of order (see order definitions) then the conversation finishes after you have confirmed the order with Broker. Your record. It is very important to make a note of all your orders, recording the time, date, and the type of order placed. You should check all fills given to you against your own record and the written confirmation sent to you the next day.
Order Details.
The following outlines the futures order process in more detail.
Client wishes to purchase for $52.00 per barrel, 5 contracts of June NYMEX Crude Oil today. The current price stands at $52.35 per barrel, which is higher than Client is willing to pay.
This is how the order should be passed to Renesource Capital futures trading desk over the telephone, divided into its component parts:
1 2 3 4 5 6 7 8 Robert Middleton Account FUT123 Buy 5 June 2015 CME Group NYMEX WTI Crude Oil $22.00 Limit Day order.
1. State your name and account number. Do not assume that the Broker knows who you are.
2. State whether this order is a Buy or Sell. Broker’s order ticket is divided in two halves; one side is for buy orders and one side is for sell orders. Until the Broker knows what side to write your instruction on, he cannot take your order. Renesource Capital recommends that you repeat this part of the order to ensure complete agreement on this point by both of you.
3. State the quantity/ number of contracts.
4. State the delivery month. Many contracts including NYMEX WTI Crude Oil are deliverable this year (near month future) and also next year as well (far month future). Therefore, it is good trading practice to state the month and also the year of the contract that you wish to trade. Renesource Capital recommend that because some months can sound similar on the telephone, such as September and December, you elaborate by saying September Labour Day and December Christmas or July Independence day to avoid any confusion.
5. State the exchange and contract to be traded. Although it can be obvious in many cases, there are many similar or identical contracts that trade on at least two different exchanges. Once again, it is good trading practice to specify the exchange as well as the contract.
6. State the price. Specify the price at which you want your order to be activated. Renesource Capital recommends that for certain numbers that sound similar to others, you clarify these: fifteen would be stated as "fifteen that is one – five" and fifty would be stated as "fifty, that is five – zero".
Most orders are either:
market orders price orders or a combination of the two.
It is very important that you state the type of order to ensure correct execution. In the NYMEX WTI Crude Oil order example above, the client stipulated a "Limit Order". In the next section, we describe the various applications for different restrictions you may wish to place on orders.
8. State type of order.
Unless stated differently most brokerage firms will assume the order will remain valid for the day only. However, it is good practice to state whether it is a Day Order or a Good Till Cancelled Order ("GTC"). (Also known as an Open Order).
Let us consider the differences.
Day Order. This is good only for the trading session during which you placed the order. If you place an order between two of the sessions, the order will remain good for the next session only, unless you specify otherwise.
Good Till Cancelled Order („GTC" or Open order). This remains a working order until:
it is filled it is cancelled by you or the contract expires.
The process of placing Options orders.
The procedure for the placement of "Option Orders" is slightly different to a futures order.
For example, consider buying a "Call Option" with a "Strike Price" of $60.00 on the June ’2015 NYMEX WTI Crude Oil futures contract with a "Premium Value" of $7.20:
1 2 3 4 5 6 7 8 9 10 Robert Middleton Account OPT123 Option order BUY 5 June 2015 Strike 60 NYMEX WTI Crude Oil Call Open Day order.
1. State your name and account number. Do not assume that the Broker knows who you are.
2. State that it is an option order.
6. State the strike price you wish to trade. If the option is exercised, the "Strike Price" identifies the price at which the underlying instrument will be assigned. Even if a Client never intends to exercise its option, it must have a "Strike Price."
7. State whether the option is call or put.
8. State whether this order is to open or to close.
Attention! When trading "Options" it is important to state whether you are opening a new position or closing an existing position.
Order Definitions.
Market Order.
This is the most straightforward order there is. You do not specify a price but instruct the Broker to get the best available price now. If the Client is not prepared to wait for NYMEX WTI Crude Oil to fall to $52.00/barrel and wants to get in immediately, the order would change to:
Robert Middleton, FUT123, Buy, 5 June @2015 NYMEX WTI Crude Oil, at Market.
Note: Some electronic exchanges do not recognise market orders. To overcome this, many electronic trading systems simulate a market order by placing a limit order well above or below the last trade. In normal market conditions this practise works well, however in fast market conditions some market orders can fail.
Market on Close ("MOC")
An MOC order is an instruction to fill the order, at market, but only in the closing range (the range is determined by the individual exchanges).
Market on Open.
It is an order that is to be filled in the official exchange opening range. If any part of the order cannot be filled in this period, it will automatically be cancelled.
Limit Order.
This is an order that Client will use if it wants to be filled at a certain price or better. If it is a buy limit, the price of the order is given at or below the current market price. If it is a sell limit, the price of the order is given at or above the current market price. Generally you are guaranteed a fill if the market trades through your price. However, if the market just trades at your price, you are not guaranteed a fill because there may not be enough trades occurring (enough liquidity) at your price to ensure that your particular order will be traded.
Sometimes, you may wish to place a limit order when the market is trading at or through your limit price. This order will be flagged ‘Or Better’. The Broker will then be able to inform the floor broker or input in the trading system of your intention.
An FOK order is an instruction to the broker to immediately execute your order at a specific price or cancel it if it is "unable" to be filled. The broker on receipt of your order will immediately "Bid" (if it is a buy order) or "Offer" (if it is a sell order) your price at least three times. If a trade takes place, you will be notified immediately of your fill price. If however no trade takes place, the order will automatically be cancelled, or "killed". The specified price must be close enough to the current market price to make its execution a reasonable possibility. In our example, the market is trading at $52.35 and our specified price is $52.00. This, therefore, would not be a realistic alternative to our normal limit order.
Market if Touched ("MIT")
A MIT order becomes a "Market Order" if and when the market hits a specified price. Just like a "Limit Order", a buy "MIT" is placed below the current market price and a sell "MIT" is placed above the current market price. However, unlike a "Limit Order" the market does not need to trade through your price to guarantee a fill. Additionally, there are no limitations placed to what price the order will be filled. It may be at your price, better, or perhaps worse – it has become a "Market Order."
This is an order that becomes a "Market Order" when trading occurs at or through your specified price. This differs from an "MIT" because a buy "Stop" is placed above the current price and is triggered when the market is bid at or above your "Stop" price. A sell "Stop" is placed below the current market price and is activated when the market is offered at or below your "Stop" price.
Many Clients refer to a "Stop Order" as a Stop Loss, in recognition of its function of closing a trade if the market price moves in the opposite direction to the one Client has anticipated. However, the "Stop Order" can also be used to protect the profit of an existing trade or to open a new position to buy "on strength" and sell "on weakness."
Consider that the market price of Crude Oil has fallen to $51.95 and Client is now in the market. The Client first concern will be to protect himself against a further significant fall in the price. Client will place a "Stop Order" using it as a Stop Loss:
Robert Middleton, FUT123, Sell, 5 June @2015 NYMEX WTI Crude Oil, at 51.50 Stop GTC.
At a later point in time, if the market moves to $52.50, the trader might want to protect the profit that he has already accrued and therefore, places a "Stop Order" to protect most of the profit:
Robert Middleton, FUT123, Sell, 5 June @2015 NYMEX WTI Crude Oil, at 52.40 Stop GTC.
Note: It is at this point that Client must remember to cancel his previous order at $51.50 Stop GTC.
It is also possible to use a stop order to open a new position. When we first looked at the NYMEX WTI Crude Oil example market the price was at $52.35/barrel. If the Client allows the price to fall before buying its 5 contracts it is buying a weak market. If, instead, he is looking for market strength in the anticipated trading direction, it may well consider using a "Stop Order" to enter "at market" if the price moves to or above 52.40.
Robert Middleton, FUT123, Buy, 5 June @2015 NYMEX WTI Crude Oil, at 52.40 Stop Day Order.
Stop Limit Order.
This is a variation of a normal "Stop Order" and it instructs the broker that on a "stop" being elected, to fill the order at the price or better. If broker is unable to do this immediately, the order will become a normal "Limit Order."
Stop Close Only Order ("SCO")
An SCO is a "Stop Order" that can only be elected and filled in the closing range of the market and will only be elected if the market has traded at or through the price specified in the "Stop Close Only Order".
Other Order Instructions.
Spread Orders.
This is an instruction to buy and sell the same or related commodities in an attempt to take advantage of the price differential.
Spread orders are entered using a "Market Order" or at a specified "Premium" instead of a price. A "Premium" is the difference in the two prices of the two contracts with which a Client wants to become involved. When giving an order, Client must always state that it is a "Spread Order". When placing Spread order, the first part that is given is the "buy side". If the order is not a "Market Order", the "Premium" should be stated on the "higher priced side". The broker will treat the "Premium" like a "Limit Order" and almost always the "Premium" is indicated on the higher priced "side" of the "Spread Order".
Let us consider an example using NYMEX WTI Crude Oil future contract. The June contract is currently trading at $52.35/barrel and the July is at $51.45/barrel. The difference between the two contracts is $0.90; that is the "Premium". The Client believes that over a period of time the difference between the two contracts, or "Premium", will reduce in size. Therefore, Client will want to sell the higher priced contract and buy at the lower priced contract. However, Client believes that the "Premium" may increase slightly before Client is able to take advantage of the anticipated decrease. The order that he will give to the broker is following:
Robert Middleton, FUT123, Spread to Buy, 5 July 2015 NYMEX WTI Crude Oil and sell 5 June 2015 NYMEX WTI Crude Oil at a premium of $1.00 or more on the Sell Side Day Order.
Note: That many brokers do not accept "Stop Orders" on spreads.
Cancel Replace.
This order will be used when a Client wants to change an existing order with respect to the price, action, quantity or duration, or a combination of any of these. With this order a Client cannot change the commodity or the month. Client informs broker what the old order is and that Client wants a "Cancel Replace" and then states the new instruction.
The advantage of this order is that it is impossible to be filled on both the old and the new orders. If the Client is too late in placing the "Cancel Replace" and the old order will be filled, the new one will be automatically cancelled and the Client will be notified of the fill. The disadvantage with the order though is the time in which it takes the order to be placed. Therefore, if it unlikely that the old order will be filled and time is of the essence, it may be worth taking a risk by placing the new order and then placing a "Straight Cancel" on the old one.
One Cancels Other ("OCO")
An OCO order consists of two separate "Buy" or "Sell" instructions. It cannot contain a "Buy" and a "Sell". As soon as the broker executes one portion of the order the second portion is cancelled. This is a very useful instruction for a Client who wants the option of placing a profit target whilst protecting the position with a stop loss. If Client considers that on the original order - Buy 5 June 2015 NYMEX WTI Crude Oil contracts, Client anticipated that the price would rise. If the market rises Client wants to take the profit and if falls Client wants to cut losses. This is an ideal opportunity to use an "OCO". Client wants to take profit using a limit order if the price rises to $53.00 and to place a stop loss if the price falls to $51.50. Both orders are "to Sell":
Robert Middleton, FUT123, OCO to Sell, 5 June 2015 NYMEX WTI Crude Oil at 53.00 Limit OCO 51.50 Stop.
Not Held Orders.
Often brokers will take an order on a "Not Held" basis. This often occurs when the exchange does not recognise a particular order and the broker offers to work the order from the desk on a "Not Held" basis. This means that broker is prepared to work the order as long as Client acknowledges that if the order is missed the broker has no liability to provide a fill. In effect a Not Held order means an order is only worked on the basis of best endeavour but no liability is accepted if it is missed.
Commodities Futures.
What are Commodities.
Commodities are broadly defined as natural resources, chemicals and physical products you can touch, taste, smell, grow, mine, consume or deliver.
From their origins in the 1800s until the 1970s, commodities and futures markets were one in the same; financial futures are a modern-day invention. To confuse things slightly, today the term "commodities" is still often used as a broad industry term describing all futures commodity contracts, including financials. For example, "commodity trading advisor" is used to define an individual or firm who operates a managed futures program, even though many of them trade exclusively in the financial futures markets such as interest rates or stock indexes.
Trading commodities that encompass physical products are the roots of today’s commodity futures industry and still play a valuable role in the global marketplace, even though the most highly traded futures today are financial contracts such as U.S. Treasury notes, Eurodollars, and Standard & Poor's 500®.
The most popular contracts for commodity trading cover several broad categories: metals, energy, grains, livestock, and food and fiber. These are not paper assets, and in general, are produced and consumed at a price based on the forces of supply and demand.
A commodity futures contract represents an agreement to buy or sell a specific type and grade of commodity for delivery at a specific time in the future at an agreed upon place at a market-determined price. In reality, commodity futures rarely lead to the delivery of an actual product, because the contract positions are typically closed out before the delivery date.
Commodity investing also includes commodity options that convey the right to buy or sell the underlying commodities futures contract.
Exchange History.
Markets for futures trading were developed initially to help agricultural producers and consumers manage the price risks they faced harvesting, marketing and processing food crops each year. Today, futures exist not only on agricultural products, but also a wide array of financial, stock and forex markets.
The world's oldest established futures exchange, the Chicago Board of Trade, was founded in 1848 by 82 Chicago merchants. The first of what were then called "to arrive" contracts were flour, timothy seed and hay, which came into use in 1849. "Forward" contracts on corn came into use in 1851 and gained popularity among merchants and food processors.
Meanwhile, what is now the nation's largest futures exchange, the Chicago Mercantile Exchange, was founded as the Chicago Butter and Egg Board in 1898. At that time, trading was offered in – you guessed it – butter and eggs.
In 2007, CME and CBOT officially merged, and are now collectively known as CME Group Inc., the world's largest and most diverse derivatives exchange.
Other prominent U.S. commodities exchanges were formed before or just after the turn of the century, and also had their roots in agriculture. At one time, you could trade on the National Metal Exchange, the Rubber Exchange of New York, the National Raw Silk Exchange, and the New York Hide Exchange. Small exchanges like these ultimately merged to become the exchanges we have today.
In the 21st century, online commodity trading has become increasingly popular, and commodity brokers offer front-end interfaces to trade these electronic-based markets. A commodities broker may also continue to offer access to the traditional pit-traded, or open-outcry, markets that established the commodity exchanges.
Types of Futures.
The most popular physical commodities contracts cover several broad categories: metals, energy, grains, livestock, and food and fiber. There are some modern additions to commodity futures that are unique, such as chemicals and fertilizer futures, but the most popular contracts fit under the broad categories listed here. Commodities are mainly subject to price fluctuations based on supply and demand factors in consuming and producing countries.
The major metals futures contracts include copper, gold, platinum, palladium and silver. Their uses include industrial purposes, in construction, and for jewelry. Geopolitical and economic factors in the dominant producing and consuming countries affect price action, but each also has its own unique fundamental influences. In the copper market, building construction is the largest demand source. Copper is also used for electrical and electronic products, transportation and industrial machinery manufacturing. The price of copper is therefore sensitive to statistics related to economic growth, particularly reports such as housing starts. For that reason, participants in financial markets often also look to price action in copper futures as a gauge of general economic trends. In another example, gold has long been used as a hedge against political and economic uncertainties, and many central banks back their currency with gold reserves.
In the U.S., the metals listed here trade primarily on the COMEX Exchange, part of CME Group. COMEX contracts trade on its Globex electronic platform.
The most popular energy futures contracts are crude oil, RBOB gasoline, heating oil and natural gas. These natural resource markets have become one of the most important gauges of world economic and political developments, and are therefore heavily influenced by disruptions in producing nations. The value of the U.S. dollar is significant because much of the world's crude oil is priced in dollars.
U.S. energy prices are quite sensitive to statistical reports detailing production, imports and especially stocks. All energy futures markets are subject to seasonal fluctuations - mild winter weather may lessen the need for heating oil, while summer tends to bring greater gasoline demand for driving season. Hurricane season in the United States impacts the energy markets as the storms can disrupt production and refining operations.
These products trade on the New York Mercantile Exchange (NYMEX), part of CME Group. NYMEX energy contracts are listed on its electronic Globex platform.
Grains and soybeans are essential to food and feed supplies, and prices are especially sensitive to weather conditions in growing areas at key times during a crop's development and to economic conditions that affect demand. Because corn is integral to the increasing popularity of ethanol fuel, the grain markets also are affected by the energy markets and outlook for fuel demand.
The major futures contracts in this category are corn, soybeans, soybean oil, soybean meal and wheat. Reports from the U.S. Department of Agriculture are closely watched, and summarize key factors influencing supply and demand including current production and carryover supply from the prior season. Each product has its own unique fundamental factors, depending on their use for human or animal consumption, or for industrial and energy needs.
These products are traded in the United States at the CME Group, Kansas City Board of Trade, and Minneapolis Grain Exchange.
Commodity futures on live cattle, feeder cattle, lean hogs and pork bellies are all traded at the CME Group. Their prices are affected by consumer demand, competing protein sources, price of feed, and factors that influence the number of animals born and sent to market, such as disease and weather.
Food and Fiber.
The food and fiber category for futures trading includes cocoa, coffee, cotton, frozen concentrated orange juice (FCOJ) and sugar. In addition to global consumer demand, the usual growing factors such as disease, insects and drought affect prices for all of these commodities. FCOJ prices, however, are particularly sensitive to weather conditions. A frost or freeze in Florida or Brazil during the growing season can have a disastrous affect on both the current crop size and long-term production prospects. International exchange rates affect all of these global products, as well as factors like tariffs and geopolitical events in producing nations. In the U.S., these markets are traded at the ICE Futures Exchange.
Market Participants.
Who Participates in Commodities Markets?
There are two basic types of participants in commodities markets–hedgers and speculators. Hedgers seek to minimize and manage price risk, while speculators take on risk in the hope of making a profit.
As an example of a hedger, you might be a large corn farmer wanting to sell your product at the highest possible price. However, unpredictable weather may create risk, as well as excess supply that could drive prices down. You could take a short position in corn futures, and if prices fall, you could then buy back the futures at a lower price than you previously had sold them. This would help you offset the loss from your cash crop and help minimize your risk. Of course, if prices rose, you'd lose money on the futures transaction, but the idea is to use futures as a hedge.
A speculator—including individual investors and professionals such as hedge funds or managed futures traders, could take the opposite side of the hedger's futures transaction. That participant would bear the risk that prices are going to rise in hopes of generating a profit on the long futures position. Most likely, this type of speculator has no actual stake in the business, other than futures trading. A commercial food producer in need of the raw product (a breakfast cereal processor, for example) may also take the other side of the short hedger's trade to offset the risk of paying higher prices for the commodity. If the price of corn rises, the commercial food producer could still capture a profit from the futures position, even though he'd be paying more for the actual corn.
An individual trader who commits his or her own capital to act as speculator on a particular exchange provide market liquidity by constantly buying and selling throughout the trading session and are viewed as important participants in the market by shouldering risk. While the term local has been used to designate those trading in the open-outcry markets, this era of electronic trading is making the phrase a little obsolete. However, their function as liquidity providers is equally important in electronic markets. The Commodity Futures Trading Commission defines this new breed of electronic traders "E-locals," but they are often more simply known as independent traders.
Trading Commodities.
What Commodities Can I Trade?
A wide variety of physical commodities markets are available to trade around the world, and new commodity futures contracts are continually being introduced.
North American exchanges that offer futures trading in physical commodities and their corresponding contract listings are listed here, although neither list is exhaustive.
Some of these commodities markets have limited liquidity and therefore can be more challenging to trade. Therefore, it is recommended you contact your commodity broker and learn more before decide to trade these markets.
CBOT – Chicago Board of Trade (part of CME Group) CME – Chicago Mercantile Exchange KCBT – Kansas City Board of Trade MGEX – Minneapolis Grain Exchange ICE Futures Canada (formerly WCE – Winnipeg Commodity Exchange) ICE Futures U.S. (formerly NYBOT – New York Board of Trade) NYMEX – New York Mercantile Exchange (part of CME Group) NYSE Liffe.
Contract Exchanges.
Chemicals.
Energy.
Fertilizer.
Food & Fiber.
Grains & Oilseeds.
Indexes.
Livestock/Meat.
Metals.
How They Are Traded.
How Are Commodities Traded?
In all futures trading, decisions are made in two ways - fundamental or technical, although many traders use a combination of both.
Fundamental Analysis.
Fundamental analysis includes all factors that influence supply and demand. For the commodities markets, fundamental factors include weather and geopolitical events in producing countries — outside forces that influence price action. In financial futures trading, factors such as Federal Reserve actions and economic reports are among fundamental forces affecting prices.
Technical Analysis.
Technical analysis is based strictly on inside market forces. It involves tracking various price patterns that occurred in the markets in the past. Analysts focus on a variety of time frames, and commodity trading decisions are based on past tendencies with the idea these price patterns tend to repeat themselves. Technical analysis involves a wide range of techniques, and a variety of market indicators are studied including volume, open interest, momentum and tools such as the MACD. Each individual analyst has his favorite approach - technical analysis is just as much art as it is science.
Gold Resource Center.
Gold is a timeless asset that has historically served as a store of wealth, a hedge against inflation and a currency alternative. Learn how you can invest in gold, and why many savvy investors and traders choose gold futures.
Gold has been prized throughout the centuries for its beauty and for its investment potential. There are many ways individuals can invest in gold, and each has its pros and cons. Savvy investors can trade gold futures and options to take advantage not only of rising prices, but also to hedge existing gold holdings and speculate on falling prices too. Learn more about how traders and investors can participate in the gold market, and the unique characteristics of futures.
Available Gold Futures Products.
Gold futures are available at the COMEX exchange (part of CME Group), as well as the NYSE Liffe U.S. exchange (part of NYSE/Euronext.)
CME Group/COMEX 100-oz. gold contract specs CME Group/COMEX E-mini 33-oz. gold contract specs CME Group/COMEX E-Micro Gold 10-oz contract specs NYSE/Liffe U.S. 100-oz. gold contract specs NYSE/Liffe U.S. 33.2-oz. gold contract specs.
Fast Track to Futures.
Are Futures Right for Me?
You might assume commodities are something only the most sophisticated investors can understand, or that you need special information or know advanced technical analysis to gain an edge. But commodities are actually very straightforward investments. They are a pure price play. All you really need is an opinion, and a plan to trade it. Unlike stocks, instead of worrying about marketmoving factors like corporate earnings reports, executive malfeasance, share buybacks or priceearnings ratios, you can focus on tangible issues that affect your daily life. You are buying or selling the things that you see, touch, taste and smell every day, based on your view of how they should be priced and your view of economic conditions. Things like gold, silver, coffee, sugar, oil and wheat—even foreign currencies, bonds and the stock market itself. Commodities are all around you! By definition, a futures contract is a legally binding agreement to buy or sell a commodity or financial instrument sometime in the future. Exchanges facilitate price discovery and standardize the quality, quantity, and delivery time and location for the markets. You can buy (go long) a futures contract if you think prices will rise, or sell (go short) if you think prices will fall, with equal ease. Like any investment, futures are not suitable for everyone. And like all investments, there is risk involved. You should not even consider investing in futures if you are looking for a “get rich quick” scheme, or are just meeting your day-to-day living expenses. Commodities can be powerful diversification tools, and have been proven to be non-correlated to traditional investments like stocks or bonds. But they also require that you do your homework before you invest. The commodity futures markets are quite diverse, and so too are the fundamentals that drive them as well as the monetary requirements to trade them.
What You Get at Renesource Capital Superior Client Service. Innovative Technology. Global Presence. Specialized Expertise.
As a futures trader, you need the right platform with the right data—tailored for futures trading. You need online resources and ongoing educational support, so you can stay on top of market trends. Wasting time hunting for the information you need means you are missing out on opportunities. At Renesource Capital, we offer several different platforms designed specifically for futures trading, with the functions futures traders require. We also offer quotes, charts and news for major commodity futures markets online anytime—all in one place that’s easy to find. And most important, if you are stuck in a losing position, have a technical problem or an important question about your account, we have live customer support available to you 24 hours during the trading week. Our licensed professionals make your success their utmost priority. We give each and every customer personal attention, no matter your account size. We believe that if you aren’t successful, neither are we.
Capital Requirements.
Have the Proper Funds. Each futures market you trade will require a different level of funding to initiate a position. This is a “good-faith” deposit known as margin, and represents a fraction of the contract’s full value. Typically, these initial margin requirements are 5%-20% of a contract’s full value. For example, the initial margin for the E-mini S&P futures was $5,000 as of June 2011. The margin for a COMEX gold contract was $6,075 as of June 2011. Some markets are even less. For example, the initial margin for CME corn futures was $1,620 and the initial margin for ICE sugar futures was $2,520 in June 2011. Please be aware margin requirements are subjectto change at any time, so contact us for the most up-to-date information. It is highly recommended you deposit more than just the minimum in your Renesource Capital account. If the market moves against you, you may have to immediately add funds to cover the loss and maintain the position.
Options on Futures.
Explore Your Options. Options on futures are another popular approach for investors with limited funds who might want a more conservative strategy. With options, you can create bullish or bearish strategies for a particular market, similar to the futures. You also can more easily define your risk with certain options strategies—when you buy puts or calls, you immediately know the maximum amount you can lose on a trade. Depending on which option strike price you choose, you can buy an option for less than $1,000, and do not need to deposit margin. So if there is a market you are interested in, ask us what funding may be required and what the various risks may be with different strategies. If you are new to options, you’ll find they open up an exciting new realm of investment opportunities for you. An option is a contract that gives the buyer the right, but not the obligation, to buy or sell the underlying contract at a specific price on or before a given date. Buying a call gives the option holder the right to buy, while buying a put gives the option holder the right to sell. The price at which the option is executed is known as the strike price. Options can be used alone or in conjunction with other market positions for a variety of strategies, including portfolio protection, risk management, speculation, to generate potential income and to possibly enhance returns.
Know the Risks.
Financial Safeguards. When you are trading, you have a lot to think about. But one thing you don’t want to worry about is whether your funds are safe. Futures operate in a transparent, regulated environment with inherent safeguards that other alternative investments may not offer. As previously mentioned, participants in the futures markets are required to deposit margin upon initiating a position, and must maintain sufficient funds to cover any subsequent losses—on a daily, and sometimes intraday, basis. This protects everyone. In volatile markets, the exchanges increase margin requirements accordingly. The availability of such funds is what makes daily cash settlements possible under all market conditions. A clearing mechanism in futures markets helps mitigate default risk to the parties of every trade. Each futures exchange has its own clearing house. All members of an exchange are required to clear their trades, from customers like you, on that exchange through the clearing house at the end of each trading session and to deposit with the clearing house a sum of money sufficient to support their clients’ positions. Each purchase of a futures contract is precisely matched to the corresponding sale, and the clearing house steps in as a neutral party to both buyer and seller. In essence, the clearing house becomes the “buyer to every seller and the seller to every buyer.” CME Group’s $7 billion financial safeguard system also includes a type of mutualized risk-management pool to which all clearing members contribute. This is a pool of liquid deposits in case a CME Group clearing member defaults. The exchange also has the ability to call on other clearing members to make additional capital contributions in case of a member firm’s default. These are the types of safeguards CME Group and other regulated exchanges offer that aren’t available in over-the-counter markets.
Regulated Exchange.
A Regulated Marketplace. In the 161-year history of the CME (including the Chicago Board of Trade and New York Mercantile Exchange), there never has been a failure of a clearing member resulting in a loss of customer funds. When you consider that over a billion trades are now processed each year at the exchange, worth over $1 quadrillion in value, that’s a pretty impressive record. On an individual level, you can also be assured that even if a clearing member firm is facing financial difficulties, your funds are secure. The Commodity Exchange Act requires that funds you deposit with a futures commission merchant (like Renesource Capital) be maintained in a “segregated” account. That means your funds can only be used by you, and are kept independent from any other funds used for firm operations, or for its debt obligations.
The Ups and Downs of Leverage. So now that you know about some of the financial safeguards in place, you need to understand an important feature of futures—leverage. Every investment, including futures, carries risk. Homeowners who believed housing values could only go up learned a hard lesson in 2008. Home ownership is a good example of the power of leverage, which is a characteristic also shared with commodity futures. Say you buy a $300,000 home with 20 percent down ($60,000). If in five years, your home appreciated to $360,000, you would have a $60,000 gain, or a 100 percent return on your initial $60,000 down payment. If however, your home falls in value to $200,000, you would be facing a loss in excess of your down payment—and if you sold your home, you’d owe the bank an additional $40,000 to cover the full mortgage value. You actually lost more than your initial investment (your $60,000 down payment). Futures operate in a similar fashion. As previously mentioned, when you initiate a futures position, you deposit margin (your “down payment”) that’s typically about 10 percent of the full contract’s value. But similar to your mortgage, you are actually responsible for the full amount the contract is worth. For example, the value of an E-mini S&P 500 futures contract is worth $50 times the current index price. So if the E-mini futures are trading at 1200, the total contract value is $60,000. The initial margin you must deposit to buy or sell a contract is only a fraction of that. (E-mini S&P 500 initial margin was just over $5,000 in June 2011.) Similar to the housing example, leverage creates the potential for magnified gains or losses in futures, with a lower up front initial investment. If the idea of leverage makes you uncomfortable, just like when you buy a home, you can avoid leverage by paying the full price of a contract instead of the margin (“down payment”). You will then see your investment value rise or fall with the market accordingly. If you deposit the full $60,000 E-mini S&P contract value in the example above, the only way you would only lose that entire amount would be if the S&P 500 fell to zero.
Futures vs. Stocks.
Take Bullish or Binary Options Bearish Positions with Equal Ease. Many stock investors pursue a buy- and-hold approach, waiting for their stock to appreciate. With futures, you can easily take the opposite strategy too, “sell-and-hold.” If you think a market is priced too high and is likely to drop, it’s just as easy to sell (go short) as it is to buy (go long). There are no special forms to fill out, no special rules and no higher financial requirements to meet. The money required to take a short, or bearish potion, is exactly the same as to take a long, or bullish position. A strategy of “sell high and buy low” is as just as reasonable and easy to execute as “buy low andsell high.” During the financial crisis of 2008, short selling certain stocks was actually prohibited for a time in the stock market—which was not the case in futures. Futures speculators could benefit from the price drops in major stock indexes as well as physical commodity products such as crude oil and grains. In fact, this ability to speculate on falling prices as well as rising prices makes futures essential for many market participants as both a hedging and speculative vehicle.
Volatility = Opportunity. Of course, the previously mentioned benefits of futures would be useless if it’s difficult to find opportunities. Futures are known for experiencing considerable price movement, and that’s another key benefit. Just look at the dramatic fluctuations in the price of crude oil in late 2010 and early 2011 and you’ll see that in action. Volatility can work for you or against you, but most speculators want markets that move. Not only that, you can trade global futures markets nearly 24 hours a day in an electronic marketplace. Opportunities are available both day and night.
Potential Tax Benefits.
Tax Treatment. Finally, futures enjoy unique tax treatment. Unlike stocks, futures do not require the accounting of individual trades. The value of futures investments is determined at the end of the year; any open trade profits or losses in the account are treated as realized profits or losses as of the last day of the year. Generally, in the U.S., securities transactions are taxed as either short-term capital gains or more favorably as long-term capital gains if held over a year. Futures transactions, however, are simply lumped together and reported on a single Form1099 at year-end because most futures contracts mature within the year. With the exception of securities futures, any profits are taxed at the “60/40” rate – 60 percent taxed at the favorable long-term capital gains rate and 40 percent taxed at the short-term capital gains rate, no matter what the holding period. An investor in a stock or ETF must hold the security a year to receive long-term capital gains treatment. We’re not tax advisors, and everyone’s situation is unique. Tax laws are also subject to change, so please consult your tax specialist about your individual circumstances.
Financial Futures.
What are Financial Futures.
Financial futures are contracts based on underlying financial instruments. There are futures trading opportunities in interest-rate sensitive instruments such as U.S. Treasury bonds, stock index futures, such as the Standard & Poor's 500® Index, or currencies, such as the Japanese yen.
Like all futures markets, a financial futures contract specifies a specific quantity of the underlying financial instrument at a market-determined price. Contracts can be settled via cash or physical delivery, depending on the instrument. Supply and demand factors determine pricing, and while common fundamentals often influence many markets globally, there are also factors unique to each particular market.
Financial futures were developed amid a rapidly growing trend toward globalization in the world's investment and economic landscape starting in the early 1970s. They were designed to meet new needs and risks that businesses, governments and individuals faced amid changing capital flows. Even though they have a shorter history than agricultural futures, they now dominate the exchange-traded product offerings. Today, the majority of activity in trading futures globally is in contracts on financial investments, and futures exchanges are continually on the lookout for new successes in this category.
Types of Financial Futures.
Interest Rate Products.
In simple terms, interest rates reflect the price of money. And like all goods and services, interest rates are determined mainly by supply and demand. A greater demand for money is likely to drive up the price of money, reflected in the interest rate. Demand depends on factors such as the nation's economic health, the level of government borrowing to support budgets, and societal perception of inflation. Also, a nation's central bank can manipulate interest rates — rates are adjusted upward in an attempt to slow the economy, while rates are adjusted downward to act as a stimulus.
Interest rate futures products encompass a range of short-term instruments, such as the Federal funds rate (an overnight inter-bank lending rate), to long-term, such as the 30-year U.S. Treasury bond. The relationship between short- and long-term interest rates along a broad time continuum is called the yield curve. Typically, the yield curve has an upward slope, with a longer period of lending risk resulting in higher rates for long-term instruments.
Eurodollar Futures.
Eurodollars are U.S. dollars on deposit in commercial banks outside the country, mainly in Europe. Eurodollars are commonly used to settle international transactions and are not guaranteed by any government, but rather, by the obligation of the bank holding them. Eurodollar futures track the interest rate on 90-day Eurodollar deposits, and frequently top the list of the world's most popular contract in futures trading.
CME Group's Eurodollar futures contract reflects the London Interbank Offered Rate (LIBOR) for a three-month, $1 million offshore deposit. The exchange lists a total of 40 quarterly futures contracts, spanning 10 years, plus the four nearest serial (nonquarterly) months. This contract is frequently used as a barometer for monetary policy implications, with a cash yield that has a close tie to the Federal funds rate. Therefore, economic statistics that may alter monetary policy have a big influence on Eurodollar futures prices.
U.S. Treasury Futures.
Because of the strength and stability of the U.S. government, which has never defaulted on debt, U.S. Treasury instruments are often described as "safe-haven" financial investments. Indeed, when strong buying occurs in the Treasury futures market because of some type of global or economic shock, it's often called a "flight to quality" among the part of global investors.
U.S. Treasury bonds are long-term debt issues of the U.S. government with maturities of more than 10 years. U.S. Treasury notes are medium-term obligations of the U.S. government with maturities that range from one to 10 years. Futures trading occurs on the 30-year bond and the two-, five- and 10-year Treasury notes. U.S. economic strength, inflation and monetary policy are the major influences on the pricing of Treasury futures. Demand for money in a strong and/or inflationary economy typically causes cash Treasury yields (i.e. the interest rate paid) to rise and the price of the futures market to fall, while conversely, a weak economy typically causes yields to fall while futures prices rise.
Treasury bills are U.S. government debt issues with maturities of up to one year. T-bills are the most widely issued government debt security and are auctioned weekly and monthly. The T-bill interest rate is considered the risk-free rate of variable return to investors. Because of their short durations, T-bills are considered money-market instruments. Treasury bills do not pay periodic interest. Instead, they are sold at a discount from their face value, and upon maturity, the investor receives the face value. The difference between the face value and the price at which it was sold is treated as interest.
Foreign Government Debt Futures.
Similar to the U.S. government, most foreign governments also issue short- and long-term debt and many have corresponding futures markets listed at exchanges around the globe. Europe's leading futures exchanges, Eurex and Euronext.liffe, offer many popular euro-based contracts including euro-bund futures, which are long-term debt instruments, and three-month euribor futures, which are short-term instruments.
Prior to the start of the European Monetary Union in 1999, German government bonds were the recognized benchmark for the European government bond market due to their liquidity, credit rating, a record of stable German monetary policy and Germany's market size and depth. Germany had been considered the "safe haven" of Eurozone issuers, but the recent integration of Europe's markets with the EMU has created new debt instruments and market dynamics.
Swap Futures.
Swaps are generally defined as agreements between two parties to exchange periodic interest payments. They have become an interest rate benchmark and are an innovative means for those seeking ways to transfer financial risk. Swap futures are traded at the CME Group and are designed to provide investors involved in U.S. dollar-denominated swaps with new trading and hedging opportunities. Investors can trade five-year, seven-year, 10-year, and 30-year swap futures contracts.
Forex Futures.
When it comes to international investing, investment managers, corporations and private investors trade currency futures, also known as foreign exchange, forex or simply FX, to manage the risks and capture potential opportunities associated with forex rate fluctuations.
Trading a nation's currency doesn't occur in a vacuum; you don't actually trade one currency but a pair based on its relationship to another currency. A number of factors go into determining the "strength" or "weakness" of a currency vs. another, but it usually comes down to comparing one nation's economy to another's. Generally, expanding economies have stronger currencies while recessionary economies have weaker currencies.
Factors influencing a currency's value include gross domestic product (GDP) as well as the trade balance between countries. The current account balance and money flows from one country to another reflect a currency's supply and demand, so futures traders are always watching each country's trade balance to see changes in surpluses/deficits. Other factors influencing currency valuations include fiscal and monetary policies, including interest rates on government-issued securities, and political leadership.
CME Group is the leader for forex futures trading in the United States, and offers a variety of contracts with pricing based on a nation's respective currency value vs. the U.S. dollar. Traders can also access cross-rate futures contracts, which allow a value comparison of a currency against another currency besides the U.S. dollar. For example, you can trade futures on the Australian dollar vs. the Canadian dollar, or British pound vs. the Japanese yen.
Stock Futures.
Some of the most popular futures contracts are related to the equity markets. Most major economies with a vibrant stock market also have a futures contract on a stock index that represents that particular economy. For example, in the United States, futures contracts are available on the Dow Jones Industrial Average as well as the broader Standard & Poor's 500 Index and the technology-oriented Nasdaq-100 Index. Other countries have similar contracts, such as the FTSE-100 in the United Kingdom, the Hang Seng in Hong Kong and the CAC 40 in France. The Dow Jones Euro STOXX 50 covers selected stocks in the euro economy.
Fundamental factors influencing stock markets encompass factors affecting companies' earnings potential, such as news about the global and domestic economy, inflation, currency values, politics and interest rates.
Index Futures.
Stock index futures contracts were introduced in the United States in 1982, nine years after listed options investing began at the Chicago Board Options Exchange, the securities offshoot of the Chicago Board of Trade. Interestingly, the CBOT had come up with the idea of futures on stocks as a way to diversify its product line, although futures on individual stocks were many more years in coming.
The Kansas City Board of Trade launched the first stock index futures contract on the Value Line in February 1982, and the Chicago Mercantile Exchange followed with its S&P 500 Index contract a few months later. The S&P contract quickly became the market leader and continues to dominate U.S. stock index futures trading today. A number of stock index futures and options contracts are now available to futures traders, covering all areas of the market. The most popular major index futures contracts are listed below.
Standard & Poor's 500® Index.
The S&P 500 Index is a market value-weighted index of 500 large-capitalization stocks traded on the New York Stock Exchange, American Stock Exchange and Nasdaq National Market System. Because the S&P is capitalization-weighted, those stocks with the most shares outstanding at the highest prices will have the most influence on the index movement. The S&P 500 index, introduced in 1957, is known as the investment industry's standard for measuring portfolio performance and is licensed by McGraw-Hill Companies Ltd.
The Chicago Mercantile Exchange introduced S&P 500 futures in 1982, and they originally traded at $500 times the cash index. As the market began to surge during the 1990s, the initial margin became too costly for many futures traders. In response, the CME decided to cut the contract's value to $250 times the index. The CME went even further to attract individual investors.
In 1997, the CME launched an even smaller version of its popular S&P 500 futures contract, which was felt to be more attractively sized for individual traders. The E-mini S&P 500 futures are priced at one-fifth the size of the big contract at $50 times the index, with a lower initial margin. But the real innovation of the new "mini" futures was the fact that they traded on an electronic platform, and not in open-outcry pits. CME officials decided trading would take place entirely on a trade-matching computer, giving traders direct access to the market and not an order-handler. Electronic trading would no longer be used only for after-hours trading or as a supplement to the primary pit contract. It became the mainstream market for the E-mini contracts. And, as long as trading was all computer-based, the CME decided to keep the market open nearly 24 hours a day. In just a year after its launch, the E-mini S&P futures were the third most active stock index contract in the country, and today, boast the strongest volume of any U.S. stock index product. Because of its strong liquidity, what started out as mainly a product for small speculators, Binary Options day-traders and other retail investors is now also an institutional favorite.
Nasdaq-100® Index.
The Nasdaq-100 Index is a modified market-capitalization index and includes the top 100 non-financial stocks (both domestic and foreign) listed on the Nasdaq Stock Market. Stocks such as Microsoft, Intel, eBay, Dell, Cisco, etc. dominate the index, so it's frequently associated with the technology sector of stock investing.
Futures on the Nasdaq-100 began trading in 1996 with a value of $100 times the index. Like the S&P 500 Index, the value of the Nasdaq-100 rose dramatically during the 1990s, and the CME launched a mini-sized electronic contract. E-mini Nasdaq-100 futures are priced at $20 time