What is a Futures Contract?

Forward and futures contracts are financial instruments that allow market participants to offset or assume the risk of a price change
of an asset over time.

A futures contract is distinct from a forward contract in two important ways: first, a futures contract is a legally binding agreement to
buy or sell a standardized asset on a specific date or during a specific month. Second, this transaction is facilitated through a futures
exchange.

The fact that futures contracts are standardized and exchange-traded makes these instruments indispensable to commodity
producers, consumers, traders and investors.

A Standardized Contract

An exchange-traded futures contract specifies the quality, quantity, physical delivery time and location for the given product. This
product can be an agricultural commodity, such as 5,000 bushels of corn to be delivered in the month of March, or it can be financial
asset, such as the U.S. dollar value of 62,500 pounds in the month of December.  

The specifications of the contract are identical for all participants. This characteristic of futures contracts allows buyer or seller to
easily transfer contract ownership to another party by way of a trade. Given the standardization of the contract specifications, the
only contract variable is price. Price is discovered by bidding and offering, also known as quoting, until a match, or trade, occurs.

Futures contracts are products created by regulated exchanges. Therefore, the exchange is responsible for standardizing the
specifications of each contract.

Exchange-Traded

The exchange also guarantees that the contract will be honored, eliminating counterparty risk. Every exchange-traded futures
contract is centrally cleared. This means that when a futures contract is bought or sold, the exchange becomes the buyer to every
seller and the seller to every buyer. This greatly reduces the credit risk associated with the default of a single buyer or seller.

The exchange thereby eliminates counterparty risk and, unlike a forward contract market, provides anonymity to futures market
participants.

By bringing confident buyers and sellers together on the same trading platform, the exchange enables participants to enter and exit
the market with ease, makings futures markets highly liquid and optimal for price discovery. 

Understanding Futures Contract Specifications

Every futures contract has these four attributes; an underlying asset, the quantity of the asset, delivery location, and delivery date. 

For example, if the underlying asset is light sweet crude oil, the quantity is 1,000 barrels, the delivery location is the Henry Hub in
Erath, Louisiana and the delivery date is December 2017.

When a party enters into a futures contract, they are agreeing to exchange an asset, or underlying, at a defined time in the future.
This asset can be a physical commodity like crude oil, or a financial product like a foreign currency.

When the asset is a physical commodity, to ensure quality, the exchange stipulates the acceptable grades of the commodity.

For example, WTI Crude Oil contracts at CME Group is for 1,000 barrels of a grade of crude oil known as “light, sweet” which refers
to the amount of hydrogen sulfide and carbon dioxide the crude oil contains.  

Futures contracts for financial products are understandably more straightforward: the U.S. dollar value of 100,000 Australian dollars
is the U.S. dollar value of 100,000 Australian dollars.

Each futures contract specifies is the quantity of the product delivered for a single contract, also known as contract size. For
example: 5,000 bushels of corn, 1,000 barrels of crude oil or Treasury bonds with a face value of $100,000 are all contract sizes as
defined in the futures contract specification.  

The exchange defines the contract size to meet the needs of market participants. For example, participants who wish to take a
speculative or hedging position in the S&P 500 futures contract but cannot risk the exposure of that size contract ($250 x the S&P
500) can instead use the E-mini S&P 500 futures contract to gain that exposure ($50 x the S&P 500 Index).  

A futures contract also specifies where the asset will be delivered upon execution. Delivery is an important consideration for certain
physical commodity markets entailing significant transportation costs. For example, the random-length lumber contract at CME
Group specifies that delivery must occur in a specific state and in a certain type of boxcar.

Finally, every futures contract is referred to by its delivery month. Traders refer to the March Corn contract or the December WTI
contract since this point in the future is germane to the value and execution of the contract position. Depending on the contract
market, delivery can be anywhere from one month to several years in the future. The exchange specifies when delivery will occur
within the month and when a given contract initiates and terminates trading. Typically, trading for a contract is halted a few days
before the specified delivery date.

What are Trading Codes? 

The display format of futures contract codes is fundamental to understanding pricing across multiple expirations.

Contract display codes are typically one- to three-letter codes identifying the product followed by additional characters indicating the
month and year of expiration. The format of a contract code varies according to the asset class and trading platform. Many contract
codes originated on the trading floor to convey maximum information with the fewest characters and migrated intact to the electronic
environment.

For this exercise, let’s first look at the E-mini S&P 500 futures contract. The CME Globex contract code this product is ES, which is
also the contract code used on CME ClearPort. Now let’s look at the Eurodollar futures contract. On CME Globex, this contract is
identified by the code GE. On CME ClearPort, this product is identified by the code ED.  It is therefore important to be aware that
contract codes can vary across platforms.

For contract expiration, additional characters added to the right of the contract code indicate month and year.

Each calendar month expiration is identified by a single letter as follows:

 January – F
 February - G
 March -H
 April -J
 May - K
 June - M
 July - N
 August - Q
 September -U
 October - V
 November -X
 December -Z

Available contract expiration months may vary by product, but the letter following the contract code always indicates expiration
month.  The expiration year is indicated following the month as a numeric value.

Let’s construct the display code for the E-mini S&P 500 futures contract expiring January 2019. The first determining factor is trading
platform and for this example we will use CME Globex. For CME Globex the E-mini S&P contract code is ES. Following ES, we add
the expiration month, which for January is the letter F. Finally, we add a 9 for 2019. Therefore the display code for the E-mini S&P
500 futures contract expiring in January 2019 is: ESF9.

These general rules apply to the format of futures contract codes, but it is important to be aware that codes and available expirations
can vary across platforms.

Overview of Expiration and Settlement

Expiration

All futures contracts have a specified date on which they expire. Prior to the expiration date, traders have a number of options to
either close out or extend their open positions without holding the trade to expiration, but some traders will choose to hold the
contract and go to settlement.

Settlement

Settlement is the fulfillment of the legal delivery obligations associated with the original contract. For some contracts, this delivery
will take place in the form of physical delivery of the underlying commodity. For example, a food producer looking to acquire grain
may be looking to take delivery of physical corn or wheat, and a farmer may be looking to deliver his grain to that producer. Although
physical delivery is an important mechanism for certain energy, metals and agriculture products, only a small percent of all
commodities futures contracts are physically delivered.

In most cases, delivery will take place in the form of cash settlement. When a contract is cash-settled, settlement takes place in the
form of a credit or debit made for the value of the contract at the time of contract expiration. The most commonly cash-settled
products are equity index and interest rate futures, although precious metals, foreign exchange, and some agricultural products may
also be settled in cash.

For traders choosing to go to settlement, the form of delivery will be highly dependent on the needs of each trader, as well as the
unique characteristics of the product being traded. 

Tick Movements: Understanding How They Work

Minimum Price Fluctuation

All futures contracts have a minimum price fluctuation also known as a tick. Tick sizes are set by the exchange and vary by contract
instrument.

E-min S&P 500 tick

For example, the tick size of an E-Mini S&P 500 Futures Contract is equal to one quarter of an index point. Since an index point is
valued at $50 for the E-Mini S&P 500, a movement of one tick would be

                   .25 x $50 = $12.50

NYMEX WTI Crude Oil

One NYMEX WTI Crude Oil futures contract is 1,000 barrels of oil. This contract is quoted in dollars and cents per barrel. Therefore
a one cent, or one tick, move in the WTI contract is worth $10.

                   1,000 x $.01 = $10

Summary

Tick sizes are defined by the exchange and vary depending on the size of the financial instrument and requirements of the
marketplace. Tick sizes are set to provide optimal liquidity and tight bid-ask spreads.

The minimum price fluctuation for any CME Group contract can be found on the product specification pages.

What are Price Limits and Price Banding

What are Price Limits?

As a trader, you want to know that there are mechanisms in place to ensure an orderly market. A regulated marketplace like CME
Group provides this order by setting price limits and price banding.

Price Limits

Price limits are the maximum price range permitted for a futures contract in each trading session. These price limits are measured in
ticks and vary from product to product. When markets hit the price limit, different actions occur depending on the product being
traded. Some markets may temporarily halt until price limits can be expanded or trading may be stopped for the day based on
regulatory rules. Different futures contracts will have different price limit rules; i.e. Equity Index futures have different rules than
Agricultural futures.
EXAMPLE

Equity Indexes futures have a three level expansion: 7%, 13% and 20% to the downside, and a 5% limit up and down in overnight
trading. Agricultural futures like Corn have a two level expansion: $0.25 then $0.40.

When price reaches any of those levels the market will go limit up or limit down.

CALCULATING PRICE LIMITS

Price limits are re-calculated daily and remain in effect for all trading days except in certain physically-deliverable markets, where
price limits are lifted prior to expiration so that futures prices are not prevented from converging on prices for the underlying
commodity.

Typically, Agricultural futures will go limit up or down most often compared to Equity Index futures which very rarely if ever go limit
up or down. When trading a specific product, it is important to be aware of price limits and the mechanisms that occur when limits
are hit. Traders also know that it is possible for limits to be reached for more than one session in a row, however the expansion of
limit thresholds over the last few years have reduced this occurrence. 

Price Banding

Price banding is a similar mechanism which subjects all orders to price validation and rejects orders outside the given band to
maintain orderly markets. Bands are calculated dynamically for each product based on the last price, plus or minus a fixed band
value. Thus, if markets quickly move in one direction, the price bands dynamically adjust to accommodate new trading ranges. 

Conclusion

It is important to note that traders can place trades outside the daily price limits. These trades will be executed when price limits and
price bands move within the specified range. So, traders still have the ability to place good-til-canceled or good-til-date orders inside
and outside daily price limits.

In the last few years there are fewer and fewer times that markets will actually go limit up or down, but it is important to be aware of
these pricing rules when you trade. 

About Contract Notional Value

Contract Unit and Contract Notional Value

Contract Unit

The contract unit is a standardized size unique to each futures contract and can be based on volume, weight, or a financial
measurement, depending on the contract and the underlying product or market.

For example, a single COMEX Gold contract unit (GC) is 100 troy ounces, which is measured by weight.

A NYMEX WTI Crude Oil contract unit (CL) is 1,000 barrels of oil, measured by volume.

The E-mini S&P 500 contract unit (ES) is a financial calculation based on a fixed multiplier times the S&P 500 Index.

Contract Notional Value

Contract notional value, also known as contract value, is the financial expression of the contract unit and the current futures contract
price.

Determining Notional Value

Assume a Gold futures contract is trading at price of $1,000. The notional value of the contract is calculated by multiplying the
contract unit by the futures price.

Contract unit x contract price = notional value

100 (troy ounces) x $1,000 = $100,000

If WTI Crude Oil is trading at $50 dollars and the contract unit is 1000 barrels, the notional would be;

$50 x 1,000 = $50,000

Now assume E-mini S&P 500 futures are trading at 2120.00. The multiplier for this contract is $50.

$50 x 2120.00 = $106,000

 
The Importance of Contract Unit and Notional Value

Notional values can be used to calculate hedge ratios versus other futures contracts or another risk position in a related underlying
market.

Hedge Ratio

How might a portfolio manager, with a $10M U.S. equity market exposure, use notional value of E-mini S&P 500 futures to
determine a hedge ratio?

Hedge ratio = value at risk/notional value

We can determine the hedge ratio using our previous example of the E-mini S&P 500 futures with a value of $106,000.

Hedge ratio = 10,000,000/106,000

Hedge ratio= 94.33 (approximately 94 contracts)

If the portfolio manager sells 94 E-mini S&P 500 futures against her long equity cash position, she has effectively hedged her
market risk.

Mark-to-market

What is Mark-to-Market?

One of the defining features of the futures markets is daily mark-to-market (MTM) prices on all contracts. The final daily settlement
price for futures is the same for everyone.

MTM was a distinctive difference between futures and forwards until the regulatory reform enacted after the financial crises of 2007-
2008. Prior to those reforms most OTC forwards and swaps did not have an official daily settlement price so clients never knew their
daily variation except as described by a theoretical pricing model.

Futures markets have an official daily settlement price set by the exchange. While contracts may have slightly different closing and
daily settlement formulas established by the exchange, the methodology is fully disclosed in the contract specifications and the
exchange rulebook.

Example

Corn futures trade on CME Globex beginning the previous evening and officially settle for the day at 13:15 Central Time (CT). CME
Group staff determine the daily settlement price of corn based on trading activity in the last minute of trading between [Link] and
[Link].

E-mini S&P 500 futures trading on CME Globex begin trade the previous evening (CT) at 5:00 p.m. The final daily settlement price is
determined by a volume-weighted average price (VWAP) of all trades executed in the full-sized, floor-traded (the Big) futures
contract and the E-mini futures contract for the designated lead month contract between [Link] and [Link] CT. The combined
VWAP for the designated lead month is then rounded to the nearest 0.10 index point. This contract then remains closed for fifteen
minutes between [Link] and [Link] and then resumes trading until [Link] (4:00 p.m. CT) when CME Globex shuts down for
one hour.

U.S. Treasury futures begin trading on CME Globex at 5:00 p.m. CT and will trade through the next day until 4:00 p.m. CT.
However, the daily settlement price is established by CME Group staff based on trading activity on CME Globex between [Link]
and [Link] CT.

In order to fully appreciate a futures contract’s final daily settlement price one needs to know the settlement procedures defined in
the contract’s specifications.

Once a futures contract’s final daily settlement price is established the back-office functions of trade reporting, daily profit/loss, and,
if required, margin adjustment is made. In the futures markets, losers pay winners every day. This means no account losses are
carried forward but must be cleared up every day. The dollar difference from the previous day’s settlement price to today’s
settlement price determines the profit or loss. If my daily loss results in my net equity falling below exchange established margin
levels I will be required to provide additional financial resources to replenish the amount back to required levels or risk liquidation of
my position.

Mark-to-market enforces the daily discipline of exchanges profit and loss between open futures positions eliminating any loss or
profit carry forwards that might endanger the clearinghouse. Having one final daily settlement for all means every open position is
treated equally. By publishing these daily settlement values the exchange provides a great service to commercial and speculative
users of the futures markets and the underlying markets they derive their price from. 

Margin: Know What’s Needed

Understanding Margin

Securities margin is the money you borrow as a partial down payment, up to 50% of the purchase price, to buy and own a stock,
bond, or ETF. This practice is often referred to as buying on margin.

Futures margin is the amount of money that you must deposit and keep on hand with your broker when you open a futures position.
It is not a down payment and you do not own the underlying commodity.

Futures margin generally represents a smaller percentage of the notional value of the contract, typically 3-12% per futures contract
as opposed to up to 50% of the face value of securities purchased on margin.

Margins Move with the Markets

When markets are changing rapidly and daily price moves become more volatile, market conditions and the clearinghouses' margin
methodology may result in higher margin requirements to account for increased risk.

When market conditions and the margin methodology warrant, margin requirements may be reduced.

Types of Futures Margin

Initial margin is the amount of funds required by CME Clearing to initiate a futures position. While CME Clearing sets the margin
amount, your broker may be required to collect additional funds for deposit.

Maintenance margin is the minimum amount that must be maintained at any given time in your account.

If the funds in your account drop below the maintenance margin level, a few things can happen: 

 You may receive a margin call where you will be required to add more funds immediately to bring the account back up to
the initial margin level.
 If you do not or can not meet the margin call, you may be able to reduce your position in accordance with the amount of
funds remaining in your account.
 Your position may be liquidated automatically once it drops below the maintenance margin level.

Summary

Futures margin is the amount of money that you must deposit and keep on hand with your broker when you open a futures position.
It is not a down payment, and you do not own the underlying commodity.

The term margin is used across multiple financial markets. However, there is difference between securities margins and futures
margins. Understanding these differences is essential, prior to trading futures contracts.

Understanding Futures Expiration & Contract Roll

The Lifespan of a Futures Contract

Futures contracts have a limited lifespan that will influence the outcome of your trades and exit strategy. The two most important
expiration terms are expiration and rollover.

Contract Expiration Options

A contract’s expiration date is the last day you can trade that contract. This typically occurs on the third Friday of the expiration
month, but varies by contract.

Prior to expiration, a futures trader has three options:

OFFSET THE POSITION

Offsetting or liquidating a position is the simplest and most common method of exiting a trade. When offsetting a position, a trader is
able to realize all profits or losses associated with that position without taking physical or cash delivery of the asset.

To offset a position, a trader must take out an opposite and equal transaction to neutralize the trade. For example, a trader who is
short two WTI Crude Oil contracts expiring in September will need to buy two WTI Crude Oil contracts expiring on the same date.
The difference in price between his initial position and offset position will represent the profit or loss on the trade.

ROLLOVER

Rollover is when a trader moves his position from the front month contract to a another contract further in the future. Traders will
determine when they need to move to the new contract by watching volume of both the expiring contract and next month contract. A
trader who is going to roll their positions may choose to switch to the next month contract when volume has reached a certain level
in that contract.

When rolling forward, a trader will simultaneously offset his current position and establish a new position in the next contract month.
For example, a trader who is long four S&P 500 futures contracts expiring in September will simultaneously sell four Sept ES
contracts and buy four Dec or further away ES contracts.

SETTLEMENT

If a trader has not offset or rolled his position prior to contract expiration, the contract will expire and the trader will go to settlement.
At this point, a trader with a short position will be obligated to deliver the underlying asset under the terms of the original contract.
This can be either physical delivery or cash settlement depending on the market.

You have choices when it comes to your futures positions at expiration. Knowing how you want to manage your trades around
rollover and expiration is important as it will directly impact the outcome of the trades.

Price discovery

Price discovery refers to the act of determining a common price for an asset. It occurs every time a seller and buyer interact in a
regulated exchange. Because of the efficiency of the futures markets and the ability for the instant dissemination of information, bid
and ask prices are available to all participants and are instantly updated across the globe.

Price discovery is the result of the interaction between sellers and buyers, or in other words, between supply and demand and
occurs thousands of times per day in the futures markets.

This auction type environment means that a trader can find trades that they feel are fair and efficient. For example, a trader in
Europe trading Corn futures (ZC) contract and a trader in Australia trading the same contract will see the same bid and ask quotes
on their trading platforms at the same time, meaning that the transaction is transparent.

The bids and offers on the futures market constantly change with supply and demand, and with news from around the world. Since
every piece of news could potentially impact the supply or demand of a specific asset, buyers and sellers adjust their prices to
reflect these changing factors with every trade that is made in that market, hence why price is always fluctuating.

What does this all mean to a trader?

It means that you can rely on the quotes you are seeing on your screen, and trade with the knowledge that you are getting the best
price, and the same price, as all others trading the same product at the same time. The one-lot order of a retail trader is treated the
same as a 100-lot order from an institutional trader, and they will both pay or receive the same price for their contracts.

The open auction system means that all available information has been assimilated in to the current price of the product, increasing
market efficiency and improving the reliability of price from one trade to the next.

The result is a global marketplace for the fair, efficient and transparent discovery of market price.

Calculating Futures Contract Profit and Loss 

Market participants trade in the futures market to make a profit or hedge against losses. Each market calculates movement of price
and size differently, and as such, traders need to be aware of how the market you are trading calculates profit and loss. To
determine the profit and loss for each contract, you will need to be aware of the contract size, tick size, current trading price, and
what you bought or sold the contract for. WTI Crude Oil futures, for example, represents the expected value of 1,000 barrels of oil.
The price of a WTI futures contract is quoted in dollars per barrel. The minimum tick size is $0.01. 

Current Value

If the current price of WTI futures is $54, the current value of the contract is determined by multiplying the current price of a barrel of
oil by the size of the contract. In this example, the current value would be $54 x 1000 = $54,000.

Value of a One-Tick Move

The dollar value of a one-tick move is calculated by multiplying the tick size by the size of the contract.

The dollar value of a one-tick move in WTI is $0.01 x 1000 = $10

Calculation Example
Calculating profit and loss on a trade is done by multiplying the dollar value of a one-tick move by the number of ticks the futures
contract has moved since you purchased the contract. This calculation gives you profit or loss per contact, then you need to multiply
this number by the number of contracts you own to get the total profit or loss for your position.

A trader buys one WTI contract at $53.60.

The price of WTI is now $54.

The profit-per-contract for the trader is $54.00-53.60 = $0.40

Therefore, the contract has moved $0.40 divided by $0.01 = 40 ticks

The total move in dollars is 40 ticks x $10 per tick = $400

The total profit would be $400 x the number of contracts the trader owns

Losses are calculated in the same manner as gains. 

The Value of Your Position 

The size of the contract can have a considerable multiplying effect on the profit and loss of a specific futures contract. Before
entering a position in the futures market, it is critical that you understand how any price fluctuation or market volatility affects the
value of your open trading position. Consider the average price move for the contract and the corresponding tick value to
understand the size of typical moves and its value.

For example, the 14-day average true range is 15 for the ES and 0.32 for Silver futures (SI) .

The calculation is as follows:

The value of a typical daily move in dollars for the ES contract = 7.5 points x $50 per point = $375

Compared to the ES contract, the SI contract is a larger contract with larger moves.

The average true range or ATR for the SI contract  $0.16 = 160 ticks

The value of a typical daily move in dollars is 160 ticks x $5 per tick = $800

This example illustrates that on average the ES contract moves less than half the dollar value of the SI contract.

Some average moves in the larger valued futures contracts can be sizable, and traders should plan their risk and reward
accordingly.

Understanding the Role of Speculators

What Are Speculators?

Speculators are primary participants in the futures market. A speculator is any individual or firm that accepts risk in order to make a
profit. Speculators can achieve these profits by buying low and selling high. But in the case of the futures market, they could just as
easily sell first and later buy at a lower price.

Obviously, this profit objective is easier said than done. Nonetheless, speculators aiming to profit in the futures market come in a
variety of types. Speculators can be individual traders, proprietary trading firms, portfolio managers, hedge funds or market makers.

Individual Traders

For individuals trading their own funds, electronic trading has helped to level the playing field by improving access to price and trade
information. The speed and ease of trade execution, combined with the application of modern risk management, gives the individual
trader access to markets and strategies that were once reserved for institutions.

Proprietary Trading Firms

Proprietary trading firms, also known as prop shops, profit as a direct result of their traders’ activity in the marketplace. These firms
supply their traders with the education and capital required to execute a large number of trades per day. By using the capital
resources of the prop shop, traders gain access to more capital than they would if they were trading on their own account. They also
may have access to the same type of research and strategies developed by larger institutions.

Portfolio or Investment Managers

A portfolio or investment manager is responsible for investing or hedging the assets of a mutual fund, exchange-traded fund or
closed-end fund. The portfolio manager implements the fund’s investment strategy and manages the day-to-day trading. Futures
markets are often used to increase or decrease the overall market exposure of a portfolio without disrupting the delicate balance of
investments that may have taken a significant effort to build.

Hedge Funds

A hedge fund is a managed portfolio of investments that uses advanced investment strategies to maximize returns, either in an
absolute sense or relative to a specified market benchmark. The name hedge fund is mostly historical, as the first hedge funds tried
to hedge against the risk of a bear market by shorting the market. Today, hedge funds use hundreds of different strategies in an
effort to maximize returns. The diverse and highly liquid futures marketplace offer hedge funds the ability to execute large
transactions and either increase or decrease the market exposure of their portfolio.

Market Makers

Market makers are trading firms that have contractually agreed to provide liquidity to the markets, continually providing both bids
and offers, usually in exchange for a reduction in trading fees. Market makers are important to the trading ecosystem as they help
facilitate the movement of large transactions without effecting a substantial change in price. Market makers often profit from
capturing the spread, the small difference between the bid and offer prices over a large number of transactions, or by trading related
futures markets that they view as being priced to provide opportunity.

Conclusion

All types of speculators bring liquidity to the market place. Providing liquidity is a crucial market function that enables individuals to
easily enter or exit the market. Though speculative trading activity generates considerable liquidity, all market players benefit. In
contrast to speculators who aim to profit by assuming market risk, some buyers and sellers have a vested interest in the underlying
asset of each contact. These market participants aim to offset or eliminate risk and are referred to as hedgers.

Understanding the Role of Hedgers

What is a Hedger?

Hedgers are primary participants in the futures markets.  A hedger is any individual or firm that buys or sells the actual physical
commodity.  Many hedgers are producers, wholesalers, retailers or manufacturers and they are affected by changes in commodity
prices, exchange rates, and interest rates. Changes to any of these variables can impact a firm’s bottom line when they bring goods
to the market. To minimize the effects of these changes hedgers will utilize futures contracts. Unlike speculators who assume
market risk for profit, hedgers use the futures markets to manage and offset risk. 

Corn Hedger Example

Let’s look at an example of a corn farmer. In the spring, the farmer is concerned about the price for his crops when he sells in the
fall.  If prices drop at harvest, the farmer will have to sell the crop at a lower price.

One way the farmer could hedge his exposure would be to sell a corn futures contract. When harvest rolls around and the price of
corn drops, he will see a loss in price when he sells his crop in the local market, however that lose would be offset by a trading gain
the futures market.  If prices rallied at harvest, the farmer would have a trading loss in the futures market but his crop would be sold
at a higher price in the local market. 

In either scenario, the hedged farmer has added protection against adverse price movements. The use of futures enabled him to
establish a price level well before the he sells the crop in his local market.  

Types of Hedgers

There are several types of hedgers in the commodities markets:

 Buy-side Hedgers: Concerned about rising commodity prices

 Sell-side Hedgers: Concerned about falling commodity prices
 Merchandisers: They both buy and sell commodities.  Their risk is different than the directional risk of a traditional buying
and selling hedger. Their risk is the spread or difference between the purchase and selling prices that determines their
profitability.

Summary
Many industries now use the risk management potential of futures contracts for a variety of assets.  The profitability of a construction
company partially depends on the cost of building materials.  By purchasing a steel futures contract, the firm is able to secure a
price at which it acquires steel.   Conversely, steel mills worried about a decline in building demand and the drop in steel prices can
sell steel futures contracts to protect against that price movement. 

Airlines now hedge against rising fuel costs through the use of crude oil futures. And jewelry manufacturers can hedge against gold
and silver price movement by utilizing precious metals futures contracts.

When it comes to hedging, there are a variety of market participants who buy and sell physical commodities, and they may benefit
from the added price protection offered by futures and options contracts.

Trading venues (pit vs online)

Understanding Trading Venues

The futures market is a dynamic marketplace that currently conducts business via the trading floor or electronic trading. While
trading has shifted to mostly electronic transactions, the trading pit still exists and maintains relevance in today’s marketplace. 

Trading Floor

Historically, all futures business was transacted on the trading floor. The trading floor was organized into segmented areas, called
pits, where traders and floor brokers met face-to-face to buy and sell futures contracts. 

Every one of those participants was a member, or associated with a member, of a specific exchange where they paid for the right to
transact business on the floor. People who wanted to participate in the futures market, but were not a member of the respective
commodity exchange, had to call a broker who would then place and order on their behalf. 

The floor was a visually dynamic marketplace and the image of traders in colorful jackets shouting orders to each other
accompanied by specific hand signals remains the image of futures trading.  However, during the 1990’s, new technology allowed
futures trading to transition to an electronic platform and online brokerages.

Electronic Trading

Access to trading platforms, lower commissions rates and sophisticated high-speed trade routing followed suit. The reduced costs of
trading meant that more participants were drawn to the futures market, which in turn had a positive effect on the liquidity of each
contract. Today any trader can transact with any other market participant. 

Trading Hours

Hours of operation for a pit trader versus a retail online trader are different. For example, the market hours for ES, which is traded
online, is Sunday through Friday 5 p.m. to 4 p.m. Central Time (CT) while the SP pit session is Monday through Friday 8:30 a.m. to
3:15 p.m. CT.

The transaction of trades may have changed over the years but the core purpose of the futures market has remained the same.
Whether on the trading floor or through the modern electronic markets, futures remain an excellent contract to trade and manage
risk. 

Midwest Grain Trade: History of Futures Exchanges

Midwest Grain Trade

Today’s futures markets are technologically sophisticated global marketplaces, trading at high speeds on electronic platforms,
around the globe, nearly 24 hours a day. But did you know that futures trading traces back to ancient Greek and Phoenician
merchants, who transported their goods for sale around the known world, opening deep and lasting global interconnections based
on trade?

Modern, electronic, globally traded futures markets have their origins in the Nineteenth-Century United States, as increasing
agricultural production and consumption necessitated a central market for delivery, sale, and purchase, and eventually price
discovery and payment and quality guarantees.

EARLY HISTORY

Early Nineteenth-Century U.S. agricultural producers and consumers were subject to drastic seasonal and supply fluctuations,
repeated gluts and shortages, and chaotic price fluctuations. During this time, storage facilities were primitive, markets were
disorganized, and production was unpredictable. In this climate, hubs of agricultural commerce began to emerge in Buffalo, New
York, for example, and other cities located around navigable U.S. waterways, enabling a central, stable market for regional
producers and consumers.
By 1848, the completion of canal and railroad infrastructure centered around Chicago linked the Great Lakes with the Mississippi
River, and Chicago became a key hub for agricultural commerce.

CHICAGO BOARD OF TRADE

During this time the Chicago Board of Trade (CBOT) formed, which would become the preeminent grain exchange in the United
States. The establishment of a central grain exchange allowed farmers and grain producers to sell their crops at set prices
throughout the months between harvests, and allowed consumers to purchase grains at transparent prices throughout the year.

After an initial period providing trading in forward contracts, the CBOT introduced standardized futures contracts in 1865. These
centrally cleared contracts, secured with the payment of performance bond or margin payments by clearing members, introduced a
level of reliability and security to buyers and sellers that stabilized markets against the possibility of default.

CHICAGO MERCANTILE EXCHANGE

The Chicago Produce Exchange was established in 1874 as a dedicated exchange for the cash trade of butter and eggs, with
defined product grades and rules of trade. To ensure quality, each keg of butter was individually smelled and tasted on the spot, and
a price agreed upon. Surplus butter was salted and stored in the basement for future sale, which drove the introduction in 1882 of
the “time contract”. In 1898, members of the Chicago Produce Exchange formed the Chicago Butter and Egg Board.

Following World War I, in 1919, the Chicago Butter and Egg Board reconstituted as the Chicago Mercantile Exchange (CME), to
form an organization to permit public participation under carefully supervised commodity trading regulations.

Throughout the 20th century, additional innovative futures contracts were introduced by the Chicago exchanges including:

 CBOT Frozen Pork Bellies futures

 CME Live Cattle futures
 CBOT Silver futures
 CME Foreign Exchange futures
 CME cash-settled Eurodollar futures
 CME S&P 500 index futures
 CBOT U.S. Treasury Bond futures

In 1992, futures contracts began trading electronically on the CME Globex platform, beginning the transition from pit-based floor
trading to the electronic platform.

CME GROUP

In 2007, the Chicago Board of Trade and Chicago Mercantile Exchange merged to form CME Group. Then in 2008, CME Group
acquires NYMEX, adding energy and metals to its wide array of product offerings. Today, tens of millions of contracts from multiple
global exchanges are traded daily across all asset classes on CME Globex with millisecond timestamp precision.

Summary

The fundamental benefits resulting from the growth and innovation of the original Midwest grain futures markets remain the
foundation and driving principal of electronic trading:

 Risk Management
 Transparency
 Price Discovery
 Liquidity
 Security

Futures Contracts Compared to Forwards

Futures vs. forwards 

Futures contracts and forward contracts are agreements to buy or sell an asset at a specific price at a specified date in the future.
These agreements allow buyers and sellers to lock in prices for physical transactions occurring at a specific future date to mitigate
the risk of price movement for the given asset through the date of delivery.

Historically, a forward contract set the terms of delivery and payment for seasonal agricultural commodities, such as wheat and
corn, between a single buyer and seller. Today, forward contracts can be for any commodity, in any amount, and delivered at any
time. Due to the customization of these products they are traded over-the-counter (OTC) or off-exchange. These types of contracts
are not centrally cleared and therefore have a higher rate of default risk.
The futures market emerged in the mid-19th century as increasingly sophisticated agricultural production, business practices,
technology, and market participants necessitated a reliable and efficient risk management mechanism. Eventually, the exchange
model established for agricultural commodities expanded to other asset classes such as equities, foreign exchange, energy, interest
rates, and precious metals.

The modern futures exchange has evolved over time and continues to serve the needs of traders and other users.  Futures
contracts are used by traders today in many ways. Traders will often use futures contracts to directly participate in a move up or
down in a particular market, without having any need for the physical commodity. Traders will hold their positions for various lengths
of time, ranging from day trading to longer term holdings of weeks to months or longer.

Differences between futures and forwards 

Consider the following differences between futures contracts and forward contracts. There are many advantages that futures
contracts provide traders.

Futures Forwards

Traded on exchange Privately negotiated

Standardized, having an exchange-specified

contract unit, expiration, tick size, and notional Customized
value

Credit default risk, since it is privately negotiated,

No counterparty risk, since payment is
and fully dependent on the counterparty for
guaranteed by the exchange clearing house
payment

Actively traded Non-transferrable

Regulated Not regulated

Characteristics of the futures contract including standardized terms, transferability, the ease with which one can enter and exit a
position, and elimination of counterparty risk, all of which have attracted a large number of market participants and established the
futures exchange as an integral component of the global economy. 

What once was an agricultural exchange has grown and now allows traders access to many unique markets like interest rate
futures, sector specific contracts, foreign currency contracts, and more. These trading opportunities are only offered through the
futures exchange.

Summary 

With the addition of trades using options on futures, two expiries per week, even more strategies and products are now available,
which leads to continued popularity for individual and institutional traders alike.

What is Volume?

Volume
Volume is reported for all futures contracts. It is calculated by counting the number of contracts that have been bought and sold over
a given time. You can track volume using different time intervals like daily or intraday.

When a futures contract is traded, whether bought or sold, it counts towards volume for that contract.

For example, a trader closes a short position in the E-mini S&P 500 (ES) futures contract by buying one contract in the ES, so
volume will increase by 1.

Traders often use and interpret the rise or decline of volume in a futures contract to help make trading decisions. 

Volume can give important information to traders such as:

 Indicate the price levels at which traders are more or less interested in trading a futures contract
 During the roll,  indicate to traders when to switch to trading the front month futures contract as volume decreases in the
expiring contract
 Identify the times of day when a futures contract is most liquid

Price Levels

When volume changes as price of a futures contract moves towards certain levels, this can indicate to a trader that a change in
direction may occur. Some traders may use this information to indicate whether to buy or sell at those key levels.

Contract Roll

During the futures rollover, traders pay attention to the contract that is taking the higher levels of volume. Traders use this
information to determine when to start trading the next month contract. As volume decreases in the expiring contract, trading will
shift to the next available month contract.

For example, say the June ES (E-mini S&P 500) futures contract is about to expire and September will become the new front month.
On the Thursday of rollover week, watch how the June contract starts to lose volume and the September contract begins to pick up
volme. When the September contract has more volume then the June contract,  it is time to switch to the September contract.

Active Periods

Traders typically prefer higher volume times to trade, as it means that more traders are actively interested in buying and selling.
When volume is high, the bid-ask spread is typically smaller, orders are filled faster and less gaps may exist between ticks.

For example, markets can have lower volume between the hours of 12:00 p.m.-2:00 p.m. ET, before major economic releases;
conversely, market often see higher volume around the open and close of the trading day.

Traders also can look at average daily volume over a longer time period, such as a few weeks or months, to see if the markets
currently are in a lower or higher volume than is typical.

Summary

What volume can’t show however, is whether traders are buying or selling, or opening or closing a position.

For example, if the ES contract is trading at 2375 and suddenly pushes down to 2360 while volume increases, the volume that
comes into the market could be from traders opening new long positions at key levels of support. That could indicate a bullish
sentiment. Volume also can be generated by liquidation of exiting long positions or opening of new short positions, a possible
bearish indication.

A spike in volume at 2360 doesn’t necessarily mean that buyers are  coming into the market and that the price will bounce.

Volume data is readily available for each futures contract and for the market as a whole.  Although traders may use volume in
different ways to interpret how to trade, volume can be an important factor to help inform your trading decisions.