One of the biggest advances in the history of commerce was the discovery that risk itself, exposure to calamity, could be commodified like anything else. Some people need to minimize or even eliminate risk, others are happy to assume risk in the anticipation of greater riches. Take a cautious soybean farmer who’ll be wiped out if prices fall, match him with a speculator willing to pay the farmer a fixed price today in hopes that prices increase, and you’ve made both parties happy. And created a futures market.

There are futures exchanges all over the world, offering contracts on a panoply of securities. Even Nepal has 6 exchanges–which means you can indeed find exchanges from here to Kathmandu. The United States has 10 major ones, including the Chicago Mercantile Exchange and three others owned by its parent company. Some exchanges are specific; for instance the Minneapolis Grain Exchange deals in futures for corn, soybeans, and different varieties of wheat. Meanwhile the IntercontinentalExchange offers futures contracts for just about everything, including edibles, currencies and gas.

If there’s a security whose price fluctuates, there can theoretically be a futures marketplace for it. This goes way beyond crops. Futures contracts for oil, gas, lumber and precious metals can all be (and are) sold today with the intention of the commodity actually being delivered months or years hence. The same goes for futures contacts for currencies, stocks, and even stock indices. Futures markets can seem dauntingly complex to the novice investor, and the corresponding quotes look indecipherable, but they really aren’t.

Futures quotes, found right next to the stock quotes on the financial sites, attempt to convey as much information as possible in 5 or so characters. For example, CLZ14. Let’s break a quote down and make sense of it, starting at the end and working our way backwards.

futures commodities screenshot

(Screenshot of barchart.com/commodityfutures/Softs)

The final two characters represent the year. That’s easy enough. The 3rd character stands for the month the contract comes due – F,G,H,J,K,M,N,Q,U,V,X or Z, respectively. So CLZ14 represents a contract for some commodity to be delivered in December of 2014.

The first two characters of the quote represent the commodity itself. There are too many 2-character codes in existence for us to list them comprehensively, but you can find almost all of them here. Most codes are intuitive. NG, natural gas. CD, Canadian dollar. OJ, orange juice, etc. There are codes for major currencies, for energy commodities (gas and oil), for grains, stock indices, meats and dairy, etc.

CL is crude oil, which trades on the New York Mercantile Exchange. The future’s extended 8-character code, CLZ14.NYM, attests to that. (There are multiple varieties of crude oil. This particular one is West Texas Intermediate, which despite its name isn’t necessarily extracted from there. The oil comes from across North America and eventually finds its way to a storage hub in…well, not even in West Texas. The West Texas Intermediate tank farms are in Oklahoma. Don’t ask.)

At the end of trading on September 12, 2014, CLZ14 closed at $90.73 per barrel. A speculator buys the contract at that price today, and if the price of oil is more than that by December, the speculator can sell his contract and profit. Whoever sells the contract today locks in the price, eliminating any chance of gains come December, and also eliminating any chance of losses.

Even if you’re not a speculator, futures prices get interesting when we compare them to the current price of the underlying commodity. Which in this case, on September 12, was $92.27. 

Depending on the commodity, you can buy futures contracts for several years out. CLZ19 is available, and sold on September 12 for $87.08[7]. If you look at the December futures contracts for the next few years, the trend is clear. From 90.73 they fall to 89.50, 88.37, 87.83, 87.60, 87.24 and finally 87.08. If you believe in the collective wisdom of the marketplace, the conclusion is inevitable. As to why market players think oil should get cheaper over the next few years, that’s presumably due to predicted increases in supply, and decreases in demand. (Not that consumers will crave less oil and oil byproducts, but rather that the oil available then will go farther and be used more efficiently.) If you’re certain that oil will increase to $100 a barrel, you should be buying up as many futures contracts as possible.

Some commodities’ trends aren’t as pronounced. Natural gas futures trade on the same exchange, and can be bought for as far as 12 years in advance. While natural gas currently sells for about $3.86 per million BTUs, NGZ26 sells for $5.49. The fluctuation is more seasonal than constant, especially when compared to crude oil, with natures gas futures prices between now and 2026 generally falling in the spring and rising in the fall.

Contracts on indices, such as the Dow Jones Industrial Average, don’t go quite as far into the future. Dow contracts trade on the Chicago Board of Trade, and are exchanged only for closing dates at the end of the quarter. The latest available contract is DJM15. That particular contract estimates a 237-point drop in the Dow level between now and then, which provides an opportunity for the undaunted speculator who’s convinced she knows something the masses don’t.

The Bottom Line

Again, you don’t ever have to partake in a futures transaction to understand the importance of futures and the information stored in their prices. But if you’re a speculator or a commodity holder, the futures market provides a place for you to find your appropriate level of risk.

 

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