One of the terms you may have caught on various financial forums or magazines is the use of the term “option futures.” This is an investment vehicle that the experienced investor can use to keep their portfolio valuable even in a fluctuating market. To understand what they are though, you need to know some underlying concepts.

Most people have a portfolio with a mixture of stocks and bonds in it. In a few cases, the investors may have thought about adding options to their portfolio. An option is a financial instrument that allows the investor to sell a security at a specified price by a certain date.

For example, you can buy an option to sell 100 shares of XYZ Co at $100 per share by March 31. If you see the price of XYZ Co stock down to $90, you can choose to exercise the option and sell those 100 shares at $100 apiece. You pocket the $10 profit on each of those shares. However, if you do not exercise the option before March 31, you do not gain anything from the transaction. This is an instrument often used to hedge the bets against a volatile market.

What are futures? Futures are contracts where one party agrees to buy an asset from another party in the future at a specified price. The investor is hoping that the value of the asset will be higher in the future than the specified price of the future. Examples make this concept a bit easier.

Let’s say that today you get a futures contract on gold at $1500 per ounce for 100 ounces. The future will come due on December 31. You know the price of gold if fluctuating all over the place. When you buy that future, you are betting that the price of gold will be higher than $1500 on December 31. When December 31 arrives, you buy the gold for $1500 per ounces for 100 ounces. If the price is $1600 per ounce on December 31^st, you are automatically $100 richer per ounce. If the price is $1400 per ounce on that day, you are down $100 per ounce.

Now bring those two concepts together for option futures. When you buy an option on futures, you purchase the right to sell futures at a given price by a certain date. So, if you own an option on those 100 ounces at $1500, you can exercise it on or before the December 31^st date, depending on the value of the gold.

On February 7, 2012 By Richard Wilson

Practice Test

Agricultural Commodities Definition

Below please find a definition of “Agricultural Commodities”

Agricultural Commodities: (First published on Commodities and Futures Guide.com) An Agricultural Commodity can be defined as grain, livestock, poultry, fruit, timber or any other items produced from agricultural activities. The general price level of an agricultural commodity, whether at a major terminal, port, or commodity futures exchange, is influenced by a variety of market forces that can alter the current or expected balance between supply and demand. Many of these forces emanate from domestic food, feed, and industrial-use markets and include consumer preferences and the changing needs of end users; factors affecting the production processes (e.g., weather, input costs, pests, diseases, etc.); relative prices of crops that can substitute in either production or consumption; government policies; and factors affecting storage and transportation.

Worldwide, there are 48 major commodity exchanges that trade over 96 commodities. The trading of commodities consists of direct physical trading and derivatives trading. Most trading is done in futures contracts, that is, agreements to deliver goods at a set time in the future for a price established at the time of the agreement. Futures trading allows both hedging to protect against serious losses in a declining market and speculation for gain in a rising market.

Some of the most well known agricultural commodities that are traded are; Corn, Mini-Corn, Wheat, Mini-Wheat, Soybean, Mini-Soybean, Soybean Meal, Soybean Oil, Soybean Crush, Oats, Rough Rice, Milk Class III, Milk Class IV, Nonfat Dry Milk, Deliverable Nonfat Dry Milk, Dry Whey, Butter, Cheese Spot Call, Random Length Lumber, Wood Pulp, Live Cattle, Lean Hogs, Feeder Cattle, and Frozen Pork Bellies.

The commodities markets have seen an upturn in the volume of trading in recent years. In the five years up to 2007, the value of global physical exports of commodities increased by 17% while the notional value outstanding of commodity OTC derivatives increased more than 500% and commodity derivative trading on exchanges more than 200%. The notional value outstanding of banks’ OTC commodities’ derivatives contracts increased 27% in 2007 to $9.0 trillion.

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Tags: commodities, futures, agricultural commodities, definition of an agriculture commodity, commodities and futures, agricultural commodities definition, CTA Fund, CTA Funds

On February 7, 2012 By Richard Wilson

Practice Test

Futures and Commodities Market Definition

Below please find a definition of “Futures and Commodities Market”

Futures and Commodities Market: The futures and commodities markets are two vital parts of the investment world but represent two very different things altogether. Commodities markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts. The futures market is an auction market in which participants buy and sell future contracts for delivery on a specified future date. Trading is carried on through open yelling and hand signals in a trading pit.

A commodities market serves the purpose of allowing two individuals to exchange the rights to goods without visual inspection. Commodity markets require the existence of agreed standards opposed to spot markets where delivery either takes place immediately, or with a minimum lag and normally involves visual inspection of the commodity or a sample of the commodity. A forward contract is an agreement between two parties to exchange at some fixed future date a given quantity of a commodity for a price defined today (buy now, pay later). Forward contracts have evolved and have been standardized into what we know today as futures contracts.

A futures contract is a type of derivative instrument, or financial contract, in which two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price. If you buy a futures contract, you are basically agreeing to buy something that a seller has not yet produced for a set price. But participating in the futures market does not necessarily mean that you will be responsible for receiving or delivering large inventories of physical commodities – remember, buyers and sellers in the futures market primarily enter into futures contracts to hedge risk or speculate rather than to exchange physical goods.

That is why futures are used as financial instruments by not only producers and consumers but also speculators. The futures market allows buyers and sellers an opportunity to manage price risks for goods they will either need to purchase or sell at a later date. An example is Boeing utilizing the futures market to hedge against an increase in the cost of aluminum at a later date which is a major component in the manufacture of an aircraft (i.e. hedging).Unlike a stock, which represents equity in a company and can be held for a long time, if not indefinitely, futures contracts have finite lives.

Free MP3 Download: To download our free 35 minute audio interview with expert Richard C. Wilson on how to succeed in the field of finance please click here.

Expand Your Financial Vocabulary: Read more finance terms and definitions

Tags: hedge fund, hedge funds, commodities, futures, futures and commodities market, what is a futures and commodities market?, commodity, futures definition, alternative investments

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