Kenanga Deutsche Futures : Futures 101 (Series 2)

Series 2

The Players

The players in the futures market fall into two broad categories: hedgers and speculators.

Trader

Short

Long

Hedger

Secure a price now to protect against future declining prices

Secure a price now to protect against future rising prices

Speculator

Secure a price now in anticipation of declining prices

Secure a price now in anticipation of rising prices

  1. Hedgers
  • A hedger buys or sells in the futures market to secure the future price of a commodity intended to be sold at a later date in the cash market. Farmers, manufacturers, importers and exporters can all be hedgers. This helps protect them against price risks.
  • The holders of the long position in futures contracts (the buyers of the commodity), are trying to secure as low a price as possible.
  • The short holders of the contract (the sellers of the commodity) want to secure as a price as high as possible.
  • The futures contract provides a definite price certainty for both parties, which reduces the risks associated with price volatility. Hedging by means of futures contracts can also be used as a means to lock in an acceptable price margin between the cost of the raw material and the retail cost of the final product sold.

Scenario Example:

Commodity Futures – Crude Palm Oil Futures (FCPO)

Anticipation of falling prices

A plantation company produces 20,000 metric tons per month (240,000 metric tons per year). Due to global economic slowdown, the plantation company anticipates demand for crude palm oil to be lower. Bursa Malaysia Derivatives’ Crude Palm Oil Futures (FCPO) contract allows the plantation company to hedge up to 2 years forward by selling futures contracts.

The plantation company decides to hedge 50% of the production up to 6 months forward onto Bursa Malaysia Derivatives FCPO.

On 13th April 2012, the trader sells 400 contracts or 10,000 metric tons in each month to September 2012.

Month

Selling Price

(MYR/MT)

Price upon expiration for physical delivery

(MYR/MT)

Net P/L (per metric tons)

P/L for 400 contracts

Apr 2012

3,568

3,510

58

580,000

May 2012

3,517

3,225

292

2,920,000

Jun 2012

3,510

2,848

662

6,620,000

Jul 2012

3,497

3,065

432

4,320,000

Aug 2012

3,477

2,862

615

6,150,000

Sep 2012

3,459

2,936

523

5,230,000

Net Profit/ (Loss)

25,820,000

The plantation company gains MYR 25.82 million from selling futures 6 months forward by using Bursa Malaysia Derivatives’ FCPO contract.

  1. Speculators or Directional Traders
  • The other market participants, however, do not aim to minimize risk but rather to benefit from the inherently risky nature of the futures market. They are known as speculators or directional traders.
  • They aim to profit from the very price change that hedgers are protecting themselves against. Hedgers want to minimize their risk no matter what they're investing in, while speculators or directional traders want to increase their risk and therefore maximize their profits.
  • In the futures market, a speculator buying a contract low in order to sell high in the future would most likely be buying that contract from a hedger selling a contract low in anticipation of declining prices in the future.
  • Unlike the hedger, the speculator does not actually seek to own the commodity in question. Rather, he or she will enter the market seeking profits by offsetting rising and declining prices through the buying and selling of contracts.
  • In a fast-paced market into which information is continuously being fed, speculators and hedgers bounce of - and benefit from - each other. The closer it gets to the time of the contract's expiration, the more solid the information entering the market will be regarding the commodity in question. Thus, all can expect a more accurate reflection of supply and demand and the corresponding price.

Scenario Example:

Commodity Futures – Crude Palm Oil Futures (FCPO)

Benefit from Bearish Markets

Referring to the high production of palm fruit this year, Fairuz anticipates there might be a decline in the price of Crude Palm Oil. To make a profit out of the bearish market, he can use the FCPO contract in the following manner:

Crude Palm Oil Futures (FCPO) is traded at MYR 2,360

Scenario:         FCPO is expected to FALL

Step 1:             Sell one FCPO contract at MYR 2,360

 

Assuming FCPO declines to MYR 2,340

Step 2:             Buy one FCPO contract at MYR 2,340

Gross profit on FCPO: MYR 500 (MYR 20 x 25)

He can also use the same strategy (short-selling) for any other indications of a bearish market.

(Source: Bursa Malaysia Derivatives)