Derivatives Made Simple: A New Way to Learn Futures

 

The price of beef in the United States is near all-time highs. This can be traced to a number of factors. Cattle herds are at their lowest levels in decades, ethanol mandates have directed more corn toward energy use and away from cattle feed, and several U.S. trade partners like Japan and Mexico have been increasing their purchases of U.S. beef. These factors and others have made producing beef more expensive and beef itself more scarce.   In 2012, one of the worst droughts in U.S. history made things even tougher. By late summer last year, the average price for a pound of ground beef in the U.S. was $3.50, according to Consumer Price Index data, the highest ever mark since CPI began recording the price.

That’s still the highest ever level. However, beef was one of commodities most impacted by the 2012 drought. Given the extreme elements the cattle market has endured lately, why haven’t the price swings been even larger? What was to keep the price of ground beef from going to, say, $5 or $6 per pound?

A big part of the answer, of course, is futures markets. Thousands of market participants come to futures markets every day to protect their business or invest capital.  For everyone else, they’re a major link in the chain to the prices and rates we pay for everyday things, like beef or a mortgage.

And for those who don’t follow markets, they can be difficult to understand. The process can be confusing and the terminology dizzying.  CME Group has created a web site aimed at making things a little easier.

FuturesFundamentals is a new take on the who, why and what of futures markets that breaks things down for those who may not spend their day trading Eurodollar futures.  The economics, the participants, the technology, terminology and impact. It’s all explored on the site through accessible stories, images, videos and quizzes .  The site is broken down into four sections:

 

The Basics

As the name of the section suggests, this is step one. It explains the reasons futures markets exist and why anyone would want to use them. Those explanations boil down to some basic truths of business:

If you buy everyday products, own property, run a business or manage money for investors, risk is all around you, every day. For some, risk stands between them and progress. For others, risk represents an opportunity to invest.

Videos on macroeconomics and a basic futures explanation help guide you through. Visit the section here.

 

The Players

This section looks at who is trading and why. Rather than focus in on the specific roles of traders, which could extend from grain elevators to the person managing your 401k, things here are broken down into two groups, hedgers and speculators, and how they work together.

For example, in the cattle situation above, Beef producers (the hedger) will survey all their risks – drought, changing exports, etc. — and could buy cattle futures or options to lock in a price for the beef they sell several months before they sell it. An investment manager (the speculator) could take the beef producer’s risk thinking the price of the contract will increase. Both sides take a side. Profits (or smaller losses) are locked in for the producer. Business goes on. And the cost of beef at the grocery store remains relatively steady.

There’s also a quiz to help visitors decide who is a hedger, and who is a speculator.

You can read more about the history of speculation here. Check out the hedgers and speculators section here.

 

See the Impact

Just as drought, exports and changing policy has impacted beef producers in recent years, changing resources and technology have made for more abundant supplies of natural gas and crude oil in the United States. Both of these markets and the factors that shape them are explained here. This section also includes a breakdown of how mortgage rates are set, and includes infographics on the things that move agricultural and energy markets.

Visit the section here.

 

Futures at Work

This focuses on the how and where of futures trading execution, the role of exchanges and how they function. Not surprisingly, much of this section is about market technology, from an explanation of algorithms to the market protections put in place to make sure markets are operating fairly for everyone. It also touches on clearing, including animated graphics that explore exactly how a trade is cleared, and what that means.  Visit the section here.

One of the strengths of the site is that it approaches the learning process from several starting points. To that end, it will periodically add articles, video and images aimed at explaining further topics associated with futures markets.

 

In the coming weeks, we’ll be featuring short interviews with participants in futures markets to help explain some of the topics presented on the site. If you have a question you would like us to explore with an industry participant, you can submit it here.  And in the spirit of education, we’ll be hosting a weekly trivia question on the CME Group Facebook page.

Evan Peterson is director of corporate marketing at CME Group and managing editor of OpenMarkets.

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