What are Commodities and What are Futures Trades?
David A. Domina
DominaLaw Group pc llo is a group of lawyers with long term and significant professional experience with commodities futures trading and related transactions litigation. The Firm helps farmers, livestock producers, dairymen and other hedge-oriented investors use the commodities markets, and enforce their rights when violations occur. Briefly, explanations related to commodities matters appear below. For more information see the U.S. Commodities Futures Trading Commission’s publications at http://cftc.gov/educationcenter/index.htm, or check elsewhere on this website or at www.dominalaw.com.
Basics of Futures Trading
What is a Futures Contract?
A futures contract is an agreement to buy or sell a specific quantity of a commodity at a specific price, at a future date. Most futures contracts permit actual delivery of the commodity to fulfill contract terms, but allow settlement with offsetting transactions or in cash. Some futures contracts require cash settlement instead of delivery; most contracts are liquidated before the delivery date. An option on a commodity futures contract gives the option buyer the right to convert the option into a futures contract. Futures and options must be executed on the floor of a commodity exchange—with very limited exceptions—and through firms registered with the CFTC.
Who Uses Futures and Options Markets?
Most participants in futures and option markets are commercial or institutional users of the commodities in which they trade. Most traders are called "hedgers;" they want the value of their assets to increase as they restrict their risks of loss. Hedgers use the commodity markets to take a position to reduce risks of financial losses with price fluctuations. Other traders are "speculators" who hope to profit from price changes. An example helps. If one ones cattle and sells them “on the board” for a future date, the cattle owner “hedges” against price deterioration. If the slaughterhouse that wants to process the cattle buys them when the cattle owner sells them, the slaughterhouse also hedges by purchasing the cattle “on the board” by protecting against a price increase. This is true of sellers and buyers who are actual users of any commodity.
History of Futures Trading in the U.S.
Futures contracts for agricultural commodities have been traded for more than 100 years. The first Federal regulation appeared the 1920s. During the past two decades, futures trading has expanded into many new product lines and beyond traditional physical and agricultural commodities. Futures and options now are offered on many energy commodities, financial instruments, foreign currencies, U.S. and foreign government securities, and U.S. and foreign stock indices. Recently added futures contracts now trade for electricity, seafood, dairy products, crop yields, and weather derivatives.
Contract Review and Market Surveillance
The CFTC reviews the terms and conditions of proposed futures and option contracts. A prosed new contract must be certified to the CFTC for approval, and be approved before trading. The CFTC conducts daily market surveillance and, in an emergency, can order an exchange to take specific action or to restore orderliness in any futures contract being traded.
Regulation of Futures Professionals
Companies and individuals who handle customer funds or give trading advice must apply for registration through the National Futures Association, a self-regulatory organization approved by the CFTC. The CFTC seeks to protect customers by:
• requiring registrants to disclose market risks and past performance information to prospective customers,
• requiring that customer funds be kept in accounts separate from those maintained by the firm for its own use, and
• requiring customer accounts to be adjusted to reflect the current market value at the close of trading each day.
The CFTC also monitors registrant supervision systems, internal controls, and sales practice compliance programs. The CFTC regularly audits compliance and takes enforcement action when necessary.
Commodity exchanges supplement CFTC’s Regulations exchange rules which they adopt. These rules cover trade clearance, trade orders and records, trading position limits and price limits, disciplinary actions, floor trading practices, and standards of business conduct. New or amended exchange rules may be implemented on certification by the exchange that the new or amended rule complies with the CFCT regulations. The CFTC is empowered to demand that an exchange to change its rules or practices if violations are found.
A futures contract is an agreement to buy or sell a specific quantity of a commodity at a specific price, at a future date. Most futures contracts permit actual delivery of the commodity to fulfill contract terms, but allow settlement with offsetting transactions or in cash. Some futures contracts require cash settlement instead of delivery; most contracts are liquidated before the delivery date. An option on a commodity futures contract gives the option buyer the right to convert the option into a futures contract. Futures and options must be executed on the floor of a commodity exchange—with very limited exceptions—and through firms registered with the CFTC.
Who Uses Futures and Options Markets?
Most participants in futures and option markets are commercial or institutional users of the commodities in which they trade. Most traders are called "hedgers;" they want the value of their assets to increase as they restrict their risks of loss. Hedgers use the commodity markets to take a position to reduce risks of financial losses with price fluctuations. Other traders are "speculators" who hope to profit from price changes. An example helps. If one ones cattle and sells them “on the board” for a future date, the cattle owner “hedges” against price deterioration. If the slaughterhouse that wants to process the cattle buys them when the cattle owner sells them, the slaughterhouse also hedges by purchasing the cattle “on the board” by protecting against a price increase. This is true of sellers and buyers who are actual users of any commodity.
History of Futures Trading in the U.S.
Futures contracts for agricultural commodities have been traded for more than 100 years. The first Federal regulation appeared the 1920s. During the past two decades, futures trading has expanded into many new product lines and beyond traditional physical and agricultural commodities. Futures and options now are offered on many energy commodities, financial instruments, foreign currencies, U.S. and foreign government securities, and U.S. and foreign stock indices. Recently added futures contracts now trade for electricity, seafood, dairy products, crop yields, and weather derivatives.
Contract Review and Market Surveillance
The CFTC reviews the terms and conditions of proposed futures and option contracts. A prosed new contract must be certified to the CFTC for approval, and be approved before trading. The CFTC conducts daily market surveillance and, in an emergency, can order an exchange to take specific action or to restore orderliness in any futures contract being traded.
Regulation of Futures Professionals
Companies and individuals who handle customer funds or give trading advice must apply for registration through the National Futures Association, a self-regulatory organization approved by the CFTC. The CFTC seeks to protect customers by:
• requiring registrants to disclose market risks and past performance information to prospective customers,
• requiring that customer funds be kept in accounts separate from those maintained by the firm for its own use, and
• requiring customer accounts to be adjusted to reflect the current market value at the close of trading each day.
The CFTC also monitors registrant supervision systems, internal controls, and sales practice compliance programs. The CFTC regularly audits compliance and takes enforcement action when necessary.
Commodity exchanges supplement CFTC’s Regulations exchange rules which they adopt. These rules cover trade clearance, trade orders and records, trading position limits and price limits, disciplinary actions, floor trading practices, and standards of business conduct. New or amended exchange rules may be implemented on certification by the exchange that the new or amended rule complies with the CFCT regulations. The CFTC is empowered to demand that an exchange to change its rules or practices if violations are found.
September, 2009
Results may vary in each case, and more specific recovery can be forecast, or extrapolated, for your case. The information on this website is general. It may not be relied upon by the reader for case-specific decisions. Accordingly, this information is not legal advice passed to a client.
© 2012 DominaLaw Group pc llo. All Rights Reserved.
© 2012 DominaLaw Group pc llo. All Rights Reserved.