Futures Final Exam
By selling a February live cattle futures contract a trader is agreeing to
Deliver a fixed quantity of live cattle at a designated location sometime in February
The Efficient Markets Hypothesis (EMH) states that futures prices provide unbiased forecasts of cash prices at delivery locations at contract maturity. In this context, what is meant by the term unbiased?
Futures prices on average do not over-predict or under-predict subsequent cash prices
A trader who is long 5 corn futures contract (5,000 bushels per contract) at $4.20 offsets her position at $4.45. Assuming commission is $50 per contract per round turn, what is her gain or loss on the trade?
Gain of $6,000
A trader who is short 2 corn futures contract (5,000 bushels per contract) at $6.40 offsets her position at $6.30. Assuming commission is $50 per contract, what is her gain or loss on the trade?
Gain of $900.
In-the-money put option premiums increase
If the underlying futures price decreases
In-the-money call option premiums increase
If the underlying futures price increases
To offset an existing long put position, an option trader must take which of the following actions?
Sell a put
How would an elevator hedge grain delivered on a cash contract at harvest-time?
Sell futures and go long-the-basis.
You buy cash corn at 450 cents/bu and sell December futures at 480 cents/bu. What have you done?
Set your buy basis at -30 December
You sell cash grain at 550 cents/bu and buy December futures at 500 cents/bu, what have you done?
Set your sell basis at +50 December
You buy December futures at 400 cents per bushel and sell March futures at 430 cents per bushel, what have you done?
Set your spread at a 30 cents carry +30 December/March
You buy December futures at 600 cents/bu and sell March futures at 650 cents/bu, what have you done?
Set your spread at a 50 cents carry
What is the difference between speculating and hedging?
Speculators have no cash position.
What is the order in which a long-the-basis transaction is completed?
Step one: buy cash and sell futures and Step two: sell cash and buy futures
Basis at a futures contract delivery location reflects what over time?
Storage costs
What 3 things can happen once an option has been bought?
The buyer can exercise it, the buyer or seller can offset it, or it expires worthless without ever being used.
Is it possible for a grain merchandiser to buy cash grain at a high price and sell it later at a lower price and still make a profit?
Yes, because merchandisers make a profit from changes in the basis
A futures contract is
a legal contract calling for the acceptance or delivery of a commodity of a specific quality and quantity to a specific delivery point on or by some subsequent data
Exercising a long call option gives you initially
a long futures position
A hog farmer buying corn for feed could use what type of futures hedge to lock in his input price?
a long-hedge
After a corn farmer has hedged his cash position he is left with
basis risk
To hedge an anticipated cash sale of corn in three months, a farmer could
buy corn put options
Lower futures price volatility will tend to
cause both call and put option premiums to decrease
What is an elevator doing when it sells cash grain and buys futures?
establishing a sell basis
One advantage to hedging the input price of a crop, using futures, as opposed to using options is
futures hedging provides better price protection when prices rise dramatically
Hedging a cash transaction with an opposite futures transaction protects against price risk because
gain or loss in the cash price is offset by a similar loss or gain in the futures
The objective of trading Long-The-Basis is to:
generate margins by capturing a rise in basis.
The intrinsic value of a Put option is
the option's strike price less the futures price
Cost-of-carry arbitrage ensures that
the relative price differences (spreads) between futures contract prices is not too large and reflects storage costs
Corn basis in the mid-west will typically be lower than corn basis in North West Arkansas because
there is typically a larger supply of corn relative to demand for corn in the Mid-West compared to North West Arkansas
A market order instructs your broker
to buy or sell a certain number of commodity futures contracts as soon as possible at the best possible price
May corn futures are trading at 520 cents/bu. May 500 puts (strike price = 500 cents/bu) are trading at a premium of 10 cents/bu. What is the time value of these puts?
10 cents/bu.
If you buy a call option for a premium of 20 cents per bushel, what's the most you can lose on the trade?
20 cents/bu
December Corn futures are trading at 480 cents/bu. December 475 calls (strike price = 475 cents/bu) are trading at a premium of 9 cents/bu. What is the time value of these calls?
4 cents/bu
You buy soybeans at -30 May and then sell them at +10 May. What was your gross margin?
40 cents/bu
You buy soybeans at -50 May and sell them at -10 May.What was your gross margin?
40 cents/bu.
December Corn futures are trading at 480 cents/bu. December 475 calls (strike price = 475 cents/bu) are trading at a premium of 9 cents/bu. What is the intrinsic value of these calls?
5 cents/bu
May corn futures are trading at 520 cents/bu. May 580 puts (strike price = 580 cents/bu) are trading at a premium of 65 cents/bu. What is the intrinsic value of these puts?
60 cents/bu.
To offset a short December Call you must?
Buy a December Call
If the cash price of corn at the Chicago futures delivery location was higher than the corn futures price at contract maturity how could someone arbitrage on this opportunity to make a risk-free profit?
Buy futures and accept delivery of the corn at a relatively low price and then sell the corn in the delivery location cash market at a relatively higher price
A speculator believes corn futures prices will increase over the next few weeks. Assuming he is correct, which of the following strategies would make him the most money
Buying corn call options
December Corn futures are trading at 480 cents/bu. December 475 puts (strike price = 475 cents/bu) are trading at a premium of 7 cents/bu. What is the intrinsic value of these puts?
0 cents/bu
In October you buy cash corn at 560 cents/bu, and sell December futures at 580 cents/bu. In November you sell cash corn at 480 cents/bu and buy December futures at 500 cents/bu. What is your gross margin on this position?
0 cents/bu
May corn futures are trading at 520 cents/bu. May 500 puts (strike price = 500 cents/bu) are trading at a premium of 10 cents/bu. What is the intrinsic value of these puts?
0 cents/bu
What are the 2 main purposes that futures are used for in a merchandising transaction?
To set basis and protect against price risk
A Call option is out-of-the money when the futures price is below the option's strike price
True
A large carry market with positive spreads throughout the crop year is typically a signal to store grain.
True
A normal or carry market structure encourages storage
True
A spread is the difference in price between two futures contracts for different delivery periods
True
An options premium changes continuously.
True
Basis tends to follow spreads
True
Convergence is the term used to describe how cash and futures prices move to the same level at a delivery location and at the end of a futures contracts life.
True
Futures contracts are standardized in terms of quality, quantity and delivery time
True
Futures contracts for different delivery periods trade simultaneously at a futures exchange
True
Gold and Silver futures markets obey the cost-of-carry model
True
In futures trading it is possible to initially sell a commodity you don't own
True
Market Orders to sell futures contracts are matched against the best or highest limit order bids
True
Short options positions (calls or puts) have potentially unlimited losses
True
The Time value of options can never be negative.
True
If you sell calls as a speculator -you are betting the underlying futures price will
never rise above the calls strike price
As middlemen grain merchandisers take on farmers and end users
price risk in exchange for basis risk
To offset an existing or open long futures position a trader must
sell an equal number of contracts for the same commodity, for the same delivery month at the same exchange.
The intrinsic value of a Call option is
the futures price less the option's strike price
A farmer's production costs per acre are $500 and his yield per acre is 150 bushels. If he wants to make a profit of $100 per acre what price should he try and lock in before harvest?
$4 per bushel.
Use the following information to formulate a pre-harvest marketing plan. Your expected yield is 80 bushels/acre, your expected production costs are $300/acre and you would like to earn $100/acre profit on your grain. What price should you try and lock in before harvest?
$5/bu
You buy the basis at -60 November and spread to the January at a 40 cents carry, what's your adjusted buy basis?
-100 January
At harvest time (October) you buy grain at an average cash price of $6.00, and sell December futures at a price of $6.50. At the end of November you sell the grain at an average price of $4.00 and buy December futures at a price of $4.10. What is your buy basis?
-50 DEC
You buy the basis at -40 November and spread to the January at a 40 cents carry, what's your adjusted buy basis?
-80 January
Futures investments are said to provide leverage because
the initial investment capital is far less than the face value of the investment itself
You Buy the Basis in mid-October at -4 Dec, spread the position at a +5 Dec/Mch carry, and in mid-January Sell the Basis at +2 Mch What is your Adjusted Buy Basis and Gross Margin?
Adjusted Buy Basis of -9 Mch and Gross Margin of 11 cents per bushel
What is the term that means that cash grain is bought and immediately resold?
Back-To-Back
What is the most important factor that makes commodities follow the cost-of-carry model?
Ease of storage of the commodity
Once you've bought a futures contract what happens next?
Either you take delivery of the commodity or you offset your position by selling a futures contract for the same delivery period.
A Put option is out-of-the money when the futures price is below the option's strike price
False
A high stocks-to-use ratio is typically associated with higher than average cash prices
False
A speculator's initial margin level can never exceed his maintenance level
False
Basis trading incurs no risk
False
Livestock is easy to store and so the cost-of-carry model can be used to explain future contract behavior in cattle and hog markets.
False
Long-hedgers benefit from a strengthening of the basis
False
The greater the time to an option's expiration the lower its value.
False
The pattern of price is more predictable than the pattern of basis from season to season.
False
The seller of a call option has the right to sell futures at the strike price
False
When a nearby futures contract price is lower than the price of a deferred future contract the spread is referred to as an inversion.
False
You see the following spreads: March/May -30May/July -30July/September -70This is a good time to be storing grain
False
Futures trading is said to be a zero sum game because
For every winning trade there has to be a losing trade
What is meant by price discovery in futures markets?
It describes the process whereby futures prices reveal the market consensus of future expected prices.
What is a price later contract?
It is a contract between a farmer and an elevator whereby the farmer transfers title of his grain to the elevator but does not price it until a later date.
A trader who is long 10 corn futures contract (5,000 bushels per contract) at $5.00 offsets her position at $4.80. Assuming commission is $50 per contract per round turn, what is her gain or loss on the trade?
Loss of $10,500
The process by which the margin accounting system is settled each trading day is referred to as
Mark-To-Market
Going Long-the-basis will be profitable if
The positive change in basis is greater than the storage costs
The U.S. government allows futures trading because
it provides the important economic benefits of price discovery and hedging
Basis is defined as
local cash price less futures price.
Hedging margin is set at the same level as a speculator's
maintenance margin
