Courses 1Lesson 1

You Could Win or Lose

If the cash market is higher by the time the crop is ready, you will not make as much as you might have.

If the price is lower, then you are fortunate to have sold prior to the decline.

Of course, you have the option of doing nothing, hoping that corn will be much higher at some point in

the future.

The essence of the futures market vehicle is, its use as a tool by which the producer and end-user can

hedge or protect profits.

Futures are ideal hedges against rising or falling prices.

What’s in it for the Players?

Who takes the other side of the futures transaction and why?  In other words:

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Who will buy the grain from you?

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Why will they buy it?

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What will they do with it?

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How will they sell it if they change their mind?

The Three Categories of “Players” in the Futures Game and their Roles

Producers

These individuals and/or firms actually produce or process the commodity that is being traded.

Whether it be silver, gold, petroleum, corn, live cattle, lumber, sugar or currencies, these are the people

who make the goods available either by mining them, harvesting them, raising them, growing them or

lending them.

They need to lock in costs.  In other words, they have a product they want to sell at a determined price.

They may do this in order to guarantee a profit on an actual commodity they have on hand or have

produced, or they may want to lock in a price on an item in order to avoid losing more money on it if

it is already declining.

Finally, they may not have the goods at all.  Rather they may be protecting themselves from a possible

side effect of declining or rising prices.

For example, a jewelry store with considerable gold and silver jewelry on hand may fear a decline in

the price of precious metals.  They stand to lose money on their inventory as prices decline.  Therefore,

they may choose to sell futures contracts of silver and/or gold in expectation of the decline.  Thus, they

have profited from the futures sale.

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© 2000 MBH Commodity Advisors, Inc.

End-Users

These are the people who will use the stuff that’s sold by producers.  They need to lock in the cost of

their production by advance purchase of raw goods.

Therefore, they will buy either on the futures market or they may make a forward contract (previously

defined).  At times, the end-user may become a seller as opposed to a buyer.

Assume, for example, that too much has been purchased or that the final product is not selling well.  In

such an event, the end-user may switch to the sell side.

The producer may, at times, switch sides as well.

Assume the producer does not have enough production to meet obligations to others.  The producer

may then become a buyer as opposed to a seller.  As you can see, roles in futures trading can change.

Speculators

This is the largest group of futures traders.  These people are sandwiched between the end-user and the

producer, providing a market buffer.

Perhaps no more than one to three percent of all futures contracts is actually completed by delivery.

The balance is closed out before any actual exchange of goods occurs.

Suffice it to say that speculators are often willing to take risks in markets at times and at prices that

may not be attractive to the other two groups.

Speculators do this in expectation of large percentage profit returns on price fluctuations.

The chart below shows the general relationship between the three basic groups of market participants.

More details will be given as your understanding of basic concepts increases.