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What's the difference between a stock exchange and a futures exchange?

At a stock exchange, the stocks bought and sold represent partial ownership in the company, which originally issued the stock. At a futures exchange, contracts are bought and sold. The contracts are standardized as to quality, quantity and delivery time and location. The only variable is price, which is "discovered" in trading on the exchange floor. The contracts represent the intent to accept or deliver a quantity of a commodity, for example, corn, soybeans, or Treasury bonds, at some future date.

Why do we need futures markets?

The price you pay for goods and services depends to a great extent on how successful businesses are in managing risk. By using the futures market effectively, businesses can minimize their risk, which, in turn, lowers their cost of doing business. This savings is passed onto you, the consumer, in the form of lower prices for food and other commodities, or a better return on a pension or investment fund.

What does the exchanges and OTC markets trade?

The exchanges and the OTC markets themselves do not trade anything. They serve as a forum, or meeting place for exchange member and credit worthy institutions to be buyers and sellers of commodities. The traders are individual member and member firms that seek to trade either agricultural commodities or financial instruments for their customers or their selves.

If grain is traded at an exchange, where is the physical commodity? (Why aren't there piles of grain outside of the building?)

Originally, the grain was brought to the regional exchanges. Farmers, who brought grain and livestock to the markets at a certain time each year often found that the immediate supply far outweighed the demand. The grain buyers, seeing such a large supply, bid the lowest price. For an example In 1865, the Chicago Board of Trade developed standardized agreements called futures contracts, which are still in use today. The contracts that are traded are for grain to be delivered at some time in the future, say September or December at specified delivery points, if delivery is desired. At the time the contracts are traded, the grain is still in the fields, in grain elevators, or perhaps not even planted. This keeps too much grain from being delivered at the same time, therefore stabilizing prices.

What is a futures contract?

A futures contract is a binding, legal agreement to buy (take delivery) or sell (make delivery of) a commodity. The terms of a futures contract are standardized by type (corn, wheat, etc.), quantity, quality, and delivery time and place. The variable portion of the contract is the price, determined at the time of the trade in a process called price discovery that takes place on our trading floor.

What is an option on a futures contract?

A futures option gives the right (but does not impose an obligation) to buy or sell a futures contract at a certain price for a limited time. Only the seller of the option is obligated to perform. There are two types of options: calls and puts.

What are calls and puts?

A "call" is an option that gives the option buyer the right (without obligation) to purchase a futures contract at a certain price on or before the expiration date of the option for a price called the premium, determined in open outcry trading in pits on the trading floor. A "put" is an option the gives the option buyer the right (without obligation) to sell a futures contract at a certain price on or before the expiration date of the option.

What is hedging and speculating?

Hedging is the practice of using the futures market for price protection involving the offsetting of price-change risk in any cash market position by taking an equal, but opposite position in the futures market. For example, a farmer may use futures or options to establish the price for his crop long before he harvests it. Various factors affect the supply and demand for that crop, causing prices to rise and fall over the growing season. The farmer can watch the prices discovered in trading at the CBOT? and, when they reflect the price he wants, will sell futures contracts to assure him of a fixed price for his crop.

Speculating is the practice of buying and selling futures contracts and options to make a profit. A speculator will buy and sell in anticipation of future price movements, but has no desire to actually own the physical commodity. Speculators, thus, assume market price risk and add liquidity and capital to the futures markets.

What is the difference between a long and short position in the market?

A short position involves selling futures contracts or purchase of a cash commodity without offsetting an offsetting futures transaction. (A cash commodity is an actual, physical commodity someone is buying or selling, such as corn or soybeans, also referred to as actuals.) A long position involves buying futures contracts or owning the cash commodity.

What kind of economic indicators do traders watch in the markets?

In any market, the forces of supply and demand directly influence price. Buyers want to acquire a product at the lowest possible price and sellers want to sell it at the highest price possible.

For agricultural commodities the various factors that affect, causing prices to rise and fall. These factors include acreage, crop yield, Government Farm Policy & Programs, exports and the weather. Statistics generated from the U.S. Department of Agriculture in its monthly crop report provide valuable information to the grain trade.

CBOT® financial instruments operate on the same premise. Suppliers of money, such as banks or thrifts, lend excess funds at a price-the interest rate.

The level of interest rates-the price of money or credit-is determined by supply and demand. Borrowers want to acquire at the lowest rate possible; lenders want to maximize their interest income.

Government policies, business conditions, Federal Reserve actions, and consumer saving and spending preferences are among the factors influencing supply and demand of loanable funds and, hence, the level of interest rates.

What is a "bull" market?

A bull market is a period of rising market prices.

What is a "bear" market?

A bear market is a period of declining market prices.

How much of what is traded actually gets delivered?

It is estimated that typically four percent or less is actually delivered. A contract may be bought and sold many times before the delivery date as businesses attempt to manage their risk. This is what accounts for the large volume traded, though relatively little is delivered, since the basic purpose of a futures contract is to provide price-change protection. (See hedging.)

Why are the trading areas on an exchange called "pits"?

Because each "pit" is a raised platform with descending steps on the inside that permit buyers and sellers to see each other. It also allows a customer's orders to move into the "pit" quickly.

Why are the pits shaped that way?

The octagonal pit shape actually makes the trading orderly. Each side of the octagon forms a "pie slice" in the pit. All the traders dealing with a certain delivery month (September for example) trade in the same slice.

Do people have assigned spots in the pits?

Yes. All the traders dealing with a certain delivery month (September, for example) trade in the same "pie slice"-shaped section of a pit. In addition, brokers, who work for institutions and/or the general public stand at the edges of the pit. From this position, they can easily see other traders and have easy access to their runners (who bring orders from phone booths). The locals, who trade only for themselves, stand in the center of the pit.

Why do traders wear colored jackets?

Exchange rules dictate that personnel on the trading floor must wear jackets and ties, but business attire is not tailored to the physical demands of the trading pit. So the trading jacket was developed as a lightweight, loose-fitting alternative in which a trader may move more freely.

Some member brokerage firms have large floor staffs. In practice, all the staff from the same brokerage firm wears the same color jackets, which sometimes also bear the company name or logo, in much the same manner that sports teams wear uniforms. This helps the staff find each other on the crowded trading floor. The jackets also help for easy recognition during active trading.

Independent traders often wear trading jackets in colors of their own choosing or they sometimes wear the same color of jacket as that of the member firm that clears their trades.

Why do traders shout and use hand signals?

Trading is conducted through a public auction system. There is no central auctioneer; each trader plays that role for himself. Through open outcry, the trader shouts the quantity of the commodity he is buying or selling, and the corresponding price he wants. The hand signals are a specialized sign language, which clarifies the traders verbal, bids and offers, particularly when trading is highly active.

What do the hand signals mean?

A trader with his palm facing inward signals a wish to buy; one with his palm outward signals a wish to sell. Each finger held vertically indicates quantity. Fingers extended horizontally express the price at which the bid or offer is made.

Why not trade by computer?

In 1994, the CBOT® launched Project A®, an electronic trading system, and most recenlty, in August 2000, the CBOT® replaced Project A® with a/c/e (Alliance/CBOT®/Eurex). The a/c/e platform is used to expand trading time after the close of the traditional open outcry trading hours to offer our members, member firms and customers additional trading opportunities. The a/c/e platform had a volume of more than 280,000 contracts during its first week of operation.

The open outcry is the primary market. The open outcry method lends more liquidity to the market because of the number of trades involved and the ability to negotiate price face to face. To negotiate price by computer each trader has to type in a price, then wait for a reply. In the world markets Traders and Introducing Brokers use both methods according to the best interest the trade.

What is a broker? A local?

A broker is a company or an individual who executes futures and options orders for financial and commercial institutions and/or the general public. A local is an individual who trades for himself.

How is the customer's investment protected?

Protecting the interests of all participants in the futures market is the responsibility of all exchange and industry members, as well as federal regulators. Working in concert, they work to maintain an honest, open trading environment for all market participants.

Rules and regulations of the each exchange are extensive and are designed to support competitive, efficient, liquid markets. These rules and regulations are scrutinized continuously by the exchanges, and are periodically amended to reflect the needs of market users.

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Disclaimer and Important Risk Warning:

You should understand that trading in the futures and or options markets is not for everyone. There is substantial risk of loss when trading futures and or options. Carefully evaluate whether trading in the futures and or options markets is appropriate, as such trading is speculative in nature. When trading futures, you may sustain losses which exceed your margin deposits. Purchasing options may result in the entire loss of premiums paid for such options. Options sellers should understand that they may be at risk of assuming a long futures position in the case of selling a put or a short futures position in the case of selling a call from the respective strike prices of such options. Past results are not necessarily indicative of future results.
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