The Farmer in the Dell (Commodities)

By: Eric Peters, Fall 2017 IAC Student Intern

The farmer’s hedging risk,

Of prices falling quick,

Before he gets the chance to sell,

His wheat to all who wish.

Futures are his game,

To lock his price in grain,

Contractually, with certainty,

Won’t hurt when prices change.

Bought on the exchange,

To standardize the range,

Of contract terms to set the norm,

Enhance this liquid game.

Regulated by the feds,

CFTC protects,

Many people trade in them,

Advise to hedge your bets.

Be wary of a fraud,

Who guarantees you all,

The NFA must register,

These traders dealing stocks.

 

Always keep in mind,

The third party consigns,

Acting as a clearing house,

Exchanges sell and buy.

Learn More:

  • Futures contracts are agreements to buy/sell a specific quantity of a commodity at a specified price on a particular date in the future
    • Metals, grains, food, and even financial instruments (currency) are traded on the futures market
  • Exchange traded commodity futures/options provide traders with contracts of a set unit size, a fixed expiration date, and centralized clearing
  • Anyone who trades futures with the public or gives advice about futures trading must be registered with the NFA (National Futures Association)
  • The Commodity Futures Trading Commission (CFTC) is the federal agency that regulates futures trading
    • They caution investors to be wary of offers for high-yield investment opportunities in futures, like commodities, because they are common areas of fraud
  • Futures markets allow commodities producers and consumers to engage in hedging in order to limit the risk of losing money as commodity prices change
    • Example: Wheat farmer who plants crop runs the risk of losing money if the price of wheat falls before harvest/sale. So, he minimizes his risk by entering into futures contracts, which guarantee the farmer will receive a pre-determined price
      • Allows the farmer to conduct business with greater certainty
    • Futures contracts are typically traded on the exchanges
      • Exchanges set standardized contract terms, amount of the commodity to be delivered, delivery months, last trading day, delivery locations, etc., to enhance liquidity
    • The exchange acts as a clearing house, acting as the buyer to all sellers and the seller to all buyers

If you want to learn more about commodities, check out advice from the SEC or the CFTC.