EXCHANGES: The U.S. Futures markets were developed out of necessity in the mid-1800’s. As our country was expanding and spreading west, farmers were having a difficult time reaching buyers efficiently. Farmers would carry tons of goods, hundreds of miles, only to have a prospective buyer back out of a deal. Quarrels repeatedly erupted relating to the quality, quantity, and price of the goods. A central marketplace where many willing and able buyers and sellers transacted business was the answer. Commodity exchanges were created to serve this function and also provide safeguards.
CONTRACTS: A legally binding contract called a "Futures" contract was developed to be traded at central locations called "exchanges". Each contract provides for the delivery of goods in the "future" at a specified date, time, and place. Each particular commodity is bought and sold in standardized contractual units, which makes them completely interchangeable. For example, each Soybean Futures contract for a specified month: is the same size, is of the same quality and grade, and is due for delivery at the same day and time.
Why Should I Be Interested In the Futures Markets?
Leverage---The "financial muscle" you create when you use a small amount of money to control an Investment worth much more.
Government regulated---The Futures markets are regulated by the Commodity Futures Trading Commission (CFTC) . There is also a self-regulatory body, the National Futures Association (NFA), to further monitor the activity of all market professionals. We encourage you to check the background of any broker or brokerage firm that you may plan to trade with. (Links are provided within this website!)
Liquidity -The U.S. Futures markets are the largest in the world in terms of trading volume and dollars, transacting hundreds of millions of dollars of trading daily.
Low transaction costs: ---For example, if you thought the price of Soybeans was going higher, you could attempt to locate a seller and buy 5,000 bushels of soybeans, (the standardized size of one Soybean Futures contract). You could have the Soybeans shipped to a warehouse, and insure it until the price hopefully rose. When you felt the price wasn’t going any higher, you would have to find a buyer, ship it to them, and hopefully receive your money. Instead, by depositing margin, (approximately $2,000 in this example) in your CFS trading account, and going long a Soybean Futures contract, you could trade Soybeans (or for that matter any other commodity or commodity option) without the hassle of locating a buyer and seller, and without incurring the extra costs of transportation, storage and insurance. Your only true cost would be your commissions and fees.
Futures Options---buyers of "calls" have virtually unlimited potential gain with limited risk; With Buyers of "puts"; Profits increase as the market falls. Break-even point will be the option exercise price. Loss is limited to amount paid for the option.
DISADVANTAGE: That same "financial muscle" created through leverage can work against you in the same degree when you misintepret market prices.
Hedgers and Speculators - Who are they?
Almost every product you consume would likely cost dramatically more without the existence of the Commodity Futures markets...Sugar, Coffee, bread (Wheat), Gasoline, and borrowing costs (Interest Rate Futures), etc would be higher. Due to all of the risks of being in business, without the ability to shift risk, a manufacturer/producer of goods or services would be forced to charge higher prices, and the user of goods (you) would incur higher costs.
HEDGERS: Shifting risk to someone willing to accept it is known as "hedging". Manufacturers can effectively lock-in a sales price by going "short"(selling) an equivalent amount of goods with Futures contracts. For example: If a mining company knew they were going to sell 1000 ounces of gold several months down the road, they could protect themselves from a future price decline by going "short" 10 gold futures contracts today (each Gold contract is 100 ounces). If the price of gold fell by $25 per ounce in the coming months, they would receive $25 less per ounce in the "cash" marketplace for their gold. But by being properly "hedged", that loss in the "cash" market would be offset by the gain made in the Futures market when they liquidated their short Gold Futures positions. A user or buyer of goods can use the Futures markets in the same manner. They would need to protect themselves from a future price increase, and therefore go long Futures contracts.
SPECULATORS: "Speculating" is done by an Investor who willingly accepts a risk, for the opportunity to profit from price movements. The lumber used in the building of you home, the mortgage on your home, the cereal, coffee, orange juice you had for breakfast and even the gas in your car would be priced many times higher without the participation of speculators in the Futures markets. Through supply and demand, market forces establish an equilibrium price, which is reached in a fair and orderly manner within the Futures exchanges.
One of the most asked questions is: "How do I sell something that I don’t own, or why would I buy something I don’t need".
The answer is simple. When trading Futures, you never actually buy or sell anything tangible; you are just contracting to do so at a future date. You are merely taking a buying or selling position as a speculator, expecting to profit from rising or falling prices. You have no intention of making or taking delivery of the commodity you are trading, your only goal is to buy low and sell high, or vice-versa. Before the contract expires you will need to liquidate your initial position. Therefore, if you oiginally entered a long position, to exit you would sell, and if you had originally entered a short position, to exit you would buy.
How is Money Made and Lost Trading Commodity Futures?
Making money in the Futures markets is achieved by either "buying" a Futures contract at a "low" price and "selling" it higher; or by "selling" it high and "buying" it lower. Losing money in Futures is done by doing the exact opposite. The following contains an example of the use of leverage in the Commodity Futures markets. No representation is being made that any account has, or is likely to achieve profits similar to those shown in these examples. If I buy 1 bushel of corn from a farmer for $2.65 per bushel, and it subsequently rises to $2.95 per bushel, haven’t I only made 30 cents? Yes, you have. But, what would have happened if you had purchased 5,000 bushels (the equivalent of 1 futures contracts) of corn? At $2.65/bushel X 5,000 bushels you would need to have spent $13,250 to initially purchase the corn. If you had a storage silo and the extra cash, and the price rose 30-cents, you would have made $1,500 (30 cents X 5,000 bushels = $1,500) less storage, insurance, transportation, and opportunity costs. If the price dropped 30-cents, you would have lost $1,500...plus storage, insurance, transportation and opportunity costs. What if you don’t have an extra $13,250 in your pocket, or a grain silo to store the corn? You can use the Futures markets! With only approximately $600 as a margin deposit, you could go long 1 corn futures contract with your CFS broker and if the price of the corn contract rose 30-cents, you would reap the same dollar reward...$1,500...earning 250% on margin, (less fees & commissions). You would incur no silo storage, delivery, or insurance costs.
The 4 Biggest reasons for losses in Futures trading:
1) Lack of a plan. Plan your trade and trade your plan. Use sound money management strategies. Determine your profit objective and where you will limit your losses. Concentrate on market signals. Goals are dreams acted upon! 2) Lack of discipline to stick with a plan once it is developed. Use discipline. Stick with stop losses, make decisions without second guessing yourself. Isolate yourself from the crowd. 3) Lack of diversification. Participate in a number of markets. Do not place all of your "eggs" in 1 basket. 4) Undercapitalization. It is exactly like running a business; you need sufficient account capitalization. Without it, you will have to shut the doors. Emphasize risk management.
Why Do I Need A Broker?
The vast majority of individuals, especially new traders, need a broker to execute trades on their behalf because investing in the Futures markets is more complex than trading stocks.
What Are Options? Explanations and examples of Calls & Puts
There are many people who choose not to trade futures contracts because they feel the potential gains do not outweigh the potential losses. For those people, options are the investment vehicle of choice. An option is simply the right, but not the obligation to buy or sell a futures contract, at a pre-determined price, (strike price) on or before a pre-determined expiration date. To go long (buy) an option requires the buyer (holder) to pay a premium. Examples of Buying Futures Options: No representation is being made that any account has, or is likely to achieve profits similar to those shown in the examples.
CALLS: Buying a call option is simply the right to buy,(go long). For example, If you felt crude prices were going to rise, you could purchase (go long) a call, and pay the premium to the seller (grantor or writer). Lets look at what would happen if Crude was trading near $22/barrel, and you purchased an at-the-money July $22 (strike price) Crude call option. For illustration purposes, we will say the premium (amount the option cost) was $600 plus fees and commissions. The call option you now own represents the right to buy 1,000 barrels of July crude at $22 barrel. For the $600 premium paid, plus fees and commissions, you would be leveraging 1,000 barrels of crude oil. Every dollar July Crude moved above your strike price, your call option position would gain $1,000 of intrinsic value. If the price rose just $3/barrel to $25, each option would be $3 in-the-money, and your call option would have an intrinsic value of $3,000. Depending on how much time value remains, and the volatility of the market, the option position may be worth more. If prices didn’t rise, your maximum risk would be limited to your original investment, ($600) plus fees and commissions. At any time prior to the expiration date, you could place an order with your CFS broker to liquidate all or part of your option position. This would further limit your risk by allowing you to recover whatever premium remained. For example, with a month of time value left, and Crude hovering around $21/barrel, let’s say your option is now worth only $200, the value having fallen from our original purchase price of $600. You may tell your CFS broker to sell your July Crude option because you feel the Crude market, and therefore your options, will not increase in value within a month. By liquidating your option, you would be recovering $200 of your original investment of $600; a sound example of money managment.
PUTS: A put option is simply the right to sell, (go short). For example, if you felt July Crude prices were going to fall from $22, you could purchase (go long) puts, and pay the premiums to the seller (grantor or writer). Imagine you purchased a July Crude $22 at-the-money put for a premium of $600, plus fees and commissions. The option you now own represents the right to sell 1,000 barrels of July crude, at $22/barrel, regardless of where the Futures price settles. Every dollar the July Crude market falls below your strike price, your put would gain $1,000 of intrinsic value. If the July Crude price fell to $19, your put would be worth a minimum of $3,000. If prices didn’t rise, your maximum risk would be limited to your original investment, $600, plus fees and commissions.
Order Types & Placement:
There are many methods of entering and exiting a market. Below are a few examples of some of the most common order types, and examples on when to use them. This is by no means an extensive listing, and it is important to realize that not all orders can be used in every market.
Market Order---The most frequently used order, which in most cases, assures you of getting in or out of a position. It is executed at the best possible price obtainable at the time the order reaches the trading pit. It DOES NOT mean your order will be filled at the last price your broker may have quoted you. An example might be telling your broker, "sell 5 contracts of September Comex Silver at the Market."
Limit Order---It is an order to buy or sell at designated price. A limit (sometimes known as an "or better") order to buy must always be placed below the current market price, and a sell limit above the current price. If the market price touches a limit order, it does not necessarily mean the order is filled. Also, a limit order may never get filled. An example of a properly placed limit order would be if the price of September Silver is currently trading at $4.50/ounce, you could tell your CFS broker to buy at $4.41, or sell at $4.67. In either case, you are looking to obtain a fill price better than the current trading price. In the case of your buy limit at $4.41, your fill price could never be higher than $4.41, but could possibly be better (lower). In the sell limit example, the fill price could never be lower than $4.67, but could possibly be better (higher).
Market-if-Touched (MIT)---They are used in the same manner as a limit order, but can be filled if the market touches your order price. If so, then the order instantly becomes a market order and you will be filled at the next available price. It could be filled above or below your initial order price.
Stop Order---This is nothing more than an order that once is touched, becomes a market order. A buy stop must always be placed above the current market price, and a sell stop below the market price. A stop order can be used to minimize a loss on a short or long position, protect a profit, or initiate a new long or short position. An example would be if September Silver were trading at $4.50, and you wanted to buy, but only if the price reached $4.60, you could place an order to "buy one September Silver at $4.60 stop." If $4.60 is touched, your order becomes a market order, and is filled accordingly.
Market on Close (MOC)---An order to be filled during the period designated by the exchange as the close, at whatever price is available. The floor broker does reserve the right to refuse an MOC up to 15 minutes before the close.
Stop Close Only (SCO)---The stop price on a stop close only will only be triggered if the market touches or exceeds the stop during the period of time the exchange has designated as the close of trading, (usually the last few minutes).
What Is Fundamental & Technical Analysis, And Why Do I Need To Learn More About It?
The answer is quite simple…because they are the tools available to assist you in your quest for profits. Find out more: Look in the Education part of this website. Risk Disclosure -- The risk of loss in trading commodity futures and options can be substantial. Before trading, one should carefully consider their financial position to determine if futures trading is appropriate. One should realize that when trading futures and/or granting/writing options one could lose the full balance of their account. It is also possible to lose more than the initial deposit when trading futures and/or granting/writing options. All funds committed should be purely risk capital.
The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of futures results.