All most the same for other types of product groups,future contract also applies as the same structure and purpose as we mentionedabove. The contractual partners can take long position or short positiondepends on their strategies. However, futures or options are considered aszero-sum game when profit of one people is the loss of the other ones.
Therefore before entering the futures contract, please taking into accountevery detail and needed information of the market’s volatility.Ø Viceversa, if you expect there is an increase of agricultural products during theperiod of the future contract, then you could take short position and become aseller who make commitment to deliver a certain amount of underlying assets ata future date for a defined money that you agree upon today. Basically, sellerwill be farmers. They are the ones who need to make sure that they can deliverall of their products in short time for the next coming harvesting season.Ø Ifyou expect there is a reduction of the agricultural products during the periodof the future contract, then you could take long position and become a buyer whomake a commitment to purchase a certain amount of underlying asset at a futuredate for a defined money that you agree upon today. Normally buyer will beproducer or investors. They are the ones who really need a stable amount ofproducts during the production process and do not want to take risk for theprice volatility in the future. If you are closely taking notice, then you willrealize all of the agricultural products are traded under the forms on futurein CME.
And of course, market makers who enter the contracts also havedifferent purposes:· Soft: coffee,sugar, cotton, etc.· Lumber · Diary: milk,cheese, etc.· Livestock: livecattle, feeder cattle, lean hog, etc.· Grains andOilseeds: corn, wheat, soybean, oats, rice, etc.when it comes to Agricultural Products, CME definitelyhad become the pioneer in this area. According to the statistics, in 1961, CMEhad first introduced its future contract on agricultural product which was thefrozen and stored belly pork meat.
Since then, agricultural and farmingproducts have been continuously diversified and added to the trading lists suchas: Futures Options · Symmetric risk profiles when the investor is free to choose the buyer/long position or seller/short position. Ex: if you enter the futures contract, at the expired date: Ø As a buyer, you are committed to buy a certain amount of assets. Ø As a seller, you are also committed to sell or deliver a certain amount of asset to contractual partner In the other way round, both contractual partners have to fulfill their duties · Asymmetric risk profiles when buyer and seller do not have the same risk profile due to their different right and duties. “Premium” is the key point that makes the differences. Ex: if you enter an option contract, at the expired date: Ø The option buyer (the one who pays premium on their contract) will have the right to execute the transaction or not. That is the reason why option buyer has limited loss potential. Ø The option seller (the one who receives premium) will not have the right to choose if they could deliver the contract or not. The decision making falls into the hands of option buyer.
That is the reason why the option seller has an unlimited loss potential. Differences: Ø Derivativefinancial instruments which are derived from an underlying’s assets. Marketsparticipants do not need to hold tangible assets for trading.Similarities:And now, let’s see what are the similarities anddifferences between futures and options: As a financial manager of a producing company which isheavily relied on petroleum in order to run the whole manufacturing system, ifyou think that the oil price will go up in the near future due to somereduction production program of OPEC (Organization of Petroleum Exporting Countries),then you immediately decide to enter a future contract to buy a lot of barrelsof oil at a future date (the expiration date can be 3 months later on) for aspecific amount of money (which is identified on the contract date). Accordingto this contract, the firm’s purpose is to hedge against the oil priceappreciation and reduce the loss.Ex:· Marketparticipants enter into an agreement to exchange a certain amount of productsat a future date for a specific amount of money. · A financialinstrument that is derived from the underlying asset’s value. In this situation,the asset could be anything from bars of gold, tons of coffee, stock, bonds oreven interest rate.
That is the reason why one more especial thing aboutderivative instrument is that the player does not need to hold a real assetssuch as real estate, stocks, bonds, foreign currency, agricultural product likecorn, coffee, rice, wheat, etc. Firstly, both futures and options are identified as asub-element within derivative. Obviously, derivative is:Therefore before going to detail of each products tosee how it works, our group will briefly introduce the definition of futuresand options and some explanations why CME is the world largest marketplace forvariety types of financial derivative instruments.
It is widely known that there are 4 main types ofproduct groups that are used to trade the most widely on the CME (ChicagoMercantile Exchange) namely equity index, interest rate, FX and agricultural.Specifically, all of those 4 main types of products are traded under the formsof futures and options.