Chances are that if something has any real effect on the bottom line of business, that something can be traded. It's true in the case of corn, soybeans, sugar and oil. But did you know you can also trade freight containers, economic indicators, carbon dioxide and the weather forecast? Soon you will even be able to bet on the weekend box office of your local movie theater.
In Pictures: 10 Tips For The Successful Long-Term Investor
All this and more exists in an ever-evolving financial canvas that allows us to trade just about anything that we can agree to terms on. Each of the products featured here was created out of a need to hedge against loss and/or preserve a profit, but most of these products couldn't exist without speculators - folks like you and me (albeit with much larger wallets) to take the other side of their protective bets. (Learn the risks in Are Derivatives Safe For Retail Investors?)
The London-based Baltic Exchange offers trading on swaps for specific trading routes, known as Forward Freight Agreements (FFAs). One party makes a bet as to whether the rate to transport something - such as crude oil from Brazil to Singapore - will be higher or lower in the future. Another party takes the other side of the bet, and the swap is settled in cash when the future date arrives.
Derivatives are assets that "derive" their value from something else. In the case of FFAs, the value of a contract is derived from the actual spot shipping rates as displayed daily by the Baltic Exchange.
Many companies trade in freight derivatives to hedge against things like rising oil prices (a major driver of freight rates) and geopolitical risks (which can affect global trading routes). Shipping rates are notoriously volatile; it's not at all uncommon for rates to swing 100% or more in a matter of months.
It may seem strange to bet on something so far out of our control as the weather. But weather has a huge impact on business, especially industries like agriculture, construction, energy, travel and insurance.
Weather derivatives aren't as simple as buying "rain tomorrow" and selling "a chilly Thursday". Instead, temperatures are averaged over a time period, such as the three months of summer and winter. These temperatures are then sliced into "ranges" and packaged for trade.
For example, your local power company could see its bottom line negatively affected if the winter is unseasonably warm, thereby lowering the demand for heating oil and gas. The power company could hedge against this outcome by purchasing a contract that would pay out cash if the temperature averaged five degrees above the historical average for the duration of winter. On the other side of that trade could be a hedge fund that was betting on the seasonal patterns, rather than the unseasonable.
The Chicago Mercantile Exchange (CME) has a wide variety of weather derivatives available for trade, covering multiple continents and over 40 global cities. These futures cover temperature ranges, snowfall amounts and frost. (For further reading, check out Introduction to Weather Derivatives.)
From weather to dangerous weather, you can actually place bets on how many hurricanes will crash against our shores in the coming year. Contracts are based on the number of hurricanes that hit specific geographic regions of the country, such as the east coast and the gulf regions.
Besides being a possible destination for the macabre speculator, these contracts are useful to insurance companies and oil producers, both of which can suffer massive losses if several big hurricanes cause damage or shut down operations during the annual hurricane season. These futures are offered on the CME alongside the temperature-based futures.
You may have heard about the energy bill being kicked around Congress that calls for a "cap and trade" system to help limit carbon-based emissions. The "trade" part involves carbon credits, a nascent system in the U.S., but a rather evolved trading mechanism in Europe.
Companies that emit carbon dioxide as a course of business are given an initial allowance of carbon credit. If they produce more carbon than allowed, they must purchase carbon credits to make up the difference. While the carbon credit system is enforced in Europe, in North America we are just beginning to test out some pilot programs, such as the Regional Greenhouse Gas Initiative, or RGGI.
The CME is setting itself up to trade RGGI futures (pending regulatory approval), while European-based futures can already be traded.
In the future, the value of carbon credits will depend on many moving parts, such as environmental legislation, geopolitical issues and the price of fossil fuels like crude oil and natural gas.
Do you think that the summer movie you saw the trailer for is destined to be the blockbuster of the year? Soon you'll be able to back up your prediction with cash. Pending approval from the Commodity Futures Trading Commission (CFTC) in a few weeks, investors will be able to buy and sell futures whose value is based on how much money a movie makes during its first month in the theaters.
The exchange, based on the existing entertainment site Hollywood Stock Exchange, will offer trading on the 30-50 movies either in the theater now or premiering in the next few months. Investors can bet on both surprise hits (buying a future) or surprise duds (selling a future).
The major players are expected to be the major movie financiers, producers and distributors looking to hedge the millions they already have invested in their projects. (Learn about investing in other areas of Hollywood. Read Analyzing Show Biz Stocks.)
The CME also offers trading on derivatives based on one of the most sensitive parts of our struggling economy - jobs. Non-farm payrolls are a highly watched economic indicator that tracks the change in jobs from month to month. The derivatives based on this indicator see their value rise $25 for every 1,000 new jobs over the prior month.
Non-farm payrolls are published by the Bureau of Labor Statistics during the first week of each month, and lately it has been one of the most important figures on Wall Street. With these products, the CME lets you hedge or wager on movements in this all-important statistic. (To learn more about this and other economic indicators, check out the Economic Indicator Tutorial)
The World of Trading Anything
It must be stated that these are fringe markets. Many are inefficient and rife with volatility. Others require specialized knowledge and/or investor credentials. But they are not small markets. Tens of billions pass through them annually, and all are showing immense growth.
None of these are meant to be core investment strategies. The serve as lesson and reminder that our financial markets are always growing, always innovating, and history tells us that in the end, this leads to stronger, healthier economies for everyone.
Still feeling uninformed? Check out last week's business news highlights in Water Cooler Finance: Zombies File Taxes, Dead Bills Rise Again.
InvestingHow do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
Mutual Funds & ETFsLearn about the differences between actively and passively managed mutual funds, and for which types of investors each management style is best suited.
Investing BasicsLearn about the ultra rich and what normally comprises their net worth; understand the top three alternative investments usually owned by the ultra rich.
Stock AnalysisLearn about the top five dividend stocks of companies operating in the health care sector that generate substantial cash flows to afford high payouts.
InvestingWealth advisers who integrate philanthropy and finance planning can stand out with baby boomer clients.
Stock AnalysisUnderstand what value hedge funds can provide investors in the financial sector. Learn about seven hedge funds that pay consistent and high dividends.
Mutual Funds & ETFsFind out what kinds of mutual funds are unsuitable for millennial investors, especially when included in millennial retirement accounts.
Bonds & Fixed IncomeTaking on high-yield bond investments requires a thorough investigation. Here are looking the fundamentals.
Mutual Funds & ETFsGet information about some of the most popular and best-performing mutual funds that are focused on commodity-related investments.
Investing BasicsFind out how you could potentially earn hundreds of thousands of dollars by just investing $100 a month in stocks during your working years.
There are some types of mutual funds, called stock funds or equity funds, which hold only stocks. However, there are a number ... Read Full Answer >>
The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
Some mutual funds pay interest, though it depends on the types of assets held in the funds' portfolios. Specifically, bond ... Read Full Answer >>
Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
Many traditional lenders and banks are failing to provide loans. In their absence, hedge funds have begun to fill the gap. ... Read Full Answer >>
Depending on the specific assets in its portfolio, a mutual fund may generate income for shareholders in the form of capital ... Read Full Answer >>