A primer on trading in futures markets

by Larry Mollner Commodity Manager Thomson & McKinnon Auchincloss Kohlmeyer Inc Los Angeles

of lumber (100 mbf KD HEMFIR 2 x 4 RL 8'-20'). This is also a valid contract which can be offset by a reverse action in the futures market before delivery time.

For example, if you bought a July lumber futures contract, you could sell a July lumber contract to offset your position (or vice versa).

Futures prices are often defined as present expectations of a price at some future time. As termination of a lumber contract (July lumber-July l5th) draws near, the price expectations can be more clearly defined. Thus a converging in price upon expiration occurs.

Story at a Glance

Part I of a brief examination of the fundamentals of futures markets, what comprises them, how and why they work and how they can be a very valuable asset to those who can successfully use them.

Convergence is also brought about because if near expiration, futures are above the cash market for the contract grade (premium), mills will sell futures rather than cash, forcing futures to lose their premium. Likewise, if futures are below cash (discount) wholesalers or retailers or users will buy futures instead of castr. This buying brings futures closer to cash. It is this converging of prices which makes futures markets a viable hedging tool. Hedging is most simply defined as strifting of risk.

The fact that futures prices move up and down and can be controlled by a small margin deposit makes them an attractive vehicle for a speculator who will position himself long 6r short in anticipation of a price change. Often criticized for his roll in price action, the speculator adds liquidity to the futuresmarket and often takes the role of assuming the price risk of a hedger by taking an opposing position.

In review, futures price action is becoming an increasingly significant factor in the volatile price movements being experienced in today's forest bontinued on page s+ )

A Glossary of Futures Market Terms

HEDGE - The purchase or sale of a futures contract as a temporary substitute for a merchandising transaction to be made at a later date.

FUTURES CONTRACT - A term used to designate a contract covering the sale of commodities for future delivery on a commodity exchange.

CASH MARKET - Market for immediate delivery and payment of commodities.

STANDARDIZED CONTRACT

Commodity in a form which meets specific exchange requirements as to its unit of trading. ..JULY" LUMBER CONTRACT

Futures contraits are traded in "months" in which they may be satisfied by making or accepting delivery (forest products trade in the contract months of March, May, July, Sept., Nov,)

CONVERGENCE - Price of cash and futures markets coming closer together as expiration of the futures contract draws near.

CONTRACT GRADE - That grade of a commodity which has been officially approved by an exchange as deliverable in settlement of a futures contract.

MARGIN - The amount deposited by a client with his broker to protect the broker against losses on contracts being carried or to be carried by the broker. A margin call is a request to deposit original margin or to maintain margin with added cash.

LONG - One who hasbought a futures contract to establish a market position.

SHORT - One who has sold a futures contract to establish a market position. The opposite of being long.

SPECULATOR - A person entering into futures contracts for any purpose other than hedging.

PERFORMANCE - The going through of executing in due form.

EXCHANGE - An association organized for the purpose of conducting trading in commodity futures.

OFFSET - The procedure by which a long or short position is liquidated by an opposite transaction.

PREMIUM - The excess of a futures price over the cash commodity.

DISCOUNT - The amount futures prices are trading less than the cash commodity.