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This guide covers key concepts in futures trading, including group formation, margin requirements, and the role of hedgers and speculators. Learn about the initial and maintenance margins in MidAm Wheat contracts, the significance of margin calls, commission rates based on different brokers, and the critical functions of futures markets such as risk transfer and price discovery. Additionally, discover the definition of hedging, how it protects against price fluctuations, and the importance of basis - the difference between cash and futures prices.
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AGEC 420 • Form groups of 3 – by Monday • Notify by e-mail Need $$ Cox, Giles, Johnson, Pankratz, Wickstrum Need names dlk7958, djs4343, kan9933,
Margins • Set by the exchange • typically around 5% of contract value • MidAm Wheat - $149 (approx 5% of 1000bu * $3) • will be increased in response to increased price or price volatility
Margin – example 1 • MidAm Wheat • Contract = 1000bu • Initial margin = $149; Maintenance = $110 • Sell March @ 285.5 • Close next day @ 288 • Receive margin call ?? • NO – (loss was $25)
Margin – example 2 • MidAm Wheat • Contract = 1000bu • Initial margin = $149; Maintenance = $110 • Buy March @ 285.5 • Close next day @ 279 • Receive margin call ?? • YES – Margin call for $65
Commissions • Set by your broker • Varies by exchange, by commodity, and by type of trade. • Range: $20 to $200 !! • Buchanan & Co. • Cattle @ MidAm (MACE): $30 per round turn • i.e., $15 in, and $15 out
Who uses futures --- and why? • Hedgers • agents dealing in the physical commodity • producers: growers, feeders • processors: millers • handlers: elevators, terminals • Speculators • no position in the physical commodity • accept risk, hope to profit • provide liquidity (trade volume without delay)
Functions of Futures Markets 1. Risk transfer: • from Hedgers • who want to manage (reduce) risk • to Speculators • willing to accept risk 2. Price discovery: • provide market’s best guess of the future price • reflects available info. on future supply and demand
Hedging Definition an attempt to reduce (manage) price risk by taking a position in the futures market opposite to that held in the cash market i.e., its an effort to lock in a price – either for selling or buying
Why hedge? • To obtain protection from an adverse price movement How ? • by an opposite position in futures to the position in cash
For hedging to work • You need the cash price and the futures price to move in the same direction • if they don’t – then the hedge won’t work
Basis difference between cash price and futures price Basis = Cash minus Futures Examples • Salina cash price $2.90/bu, March futures $3.00 • Salina basis is - $0.10 (10 under) • G.City cash price $2.80/bu, July futures $3.00 • G.City basis is - $0.20 July (20 under July)
Basis • Always quoted relative to some futures month • If the futures month is not specified assumed to be the nearby futures
Basis • Basis = Cash - Futures • ===> • Cash = Futures + Basis
Basis and Time • Basis can change over time • strengthen • from -10 to -5; from -5 to +2; from +2 to +6 • weaken • from +10 to +7; from +7 to -3; from -3 to -6
Basis and Location • Basis varies with location • because supply-demand conditions are different in different areas • Kansas -- basis typically negative • Near Gulf ports -- basis typically positive
Maturity Basis the difference between the cash price and the futures price at the maturity date of the futures contract Example • the difference between the cash price in Salina and the July futures price in July
Maturity Basis • Predictable – using historical data • But not perfectly predictable there is “basis risk”
Quiz #1 – next week For 1/2 point extra credit on Quiz #1 Approximate size of Ireland relative to Kansas
