Susan Campbell reports on new additions to our future exchange - a milling wheat futures contract.
On the 20 May 2003 the Australian Stock Exchange (ASX) launched a rather unusual product on the stock market a milling wheat futures contract. This heralds a return for wheat to the futures game. It was previously traded on the Sydney Futures Exchange (SFE) but delisted a few years ago due to lack of interest.
So what are futures? Futures are contracts that are entered into today that bind you to buy or sell a particular asset be it wheat, gold or petroleum or a cash equivalent on a specified date in the future.
Futures contracts are traded in over 100 futures exchanges across the globe. Locally, futures could only be traded on the SFE until the ASX obtained its futures licence in 2001. The ASX now offers a limited range of futures, but it is expanding and it plans to begin trading wool futures soon.
Futures contracts are traded over ASX sharemarket indices on the S&P/ASX50 Index; the S&P/ASX200 Index; the S&P/ASX200 Property Trusts Index; and now over grain futures. According to the ASX the new grain futures have been specifically designed to suit the local market with input from the largest futures broker in Australia.
When you buy an ASX mini index future, what you are doing is commiting yourself to 'buy' the index underlying the futures contract on a specified date in the future. When you sell a future, what you are doing is agreeing to 'sell' the index at that time. At maturity of the contract a 'cash settlement' takes place the contract is closed and the profit and loss is paid out in cash. Depending on how the index moved in the period since the futures contract was traded you will receive either a profit or a loss.
Full value of the futures contract is not paid or received when the contract is established instead the buyer and seller pay an initial margin (a small percentage of the value of the contract).
How is the traded price decided? The traded price will be the basis on which profit or loss is calculated at maturity or on closing out the position if this takes place before maturity. This makes it a geared or leveraged product.
With grain futures it works under a similar principle and can be used by grain producers to lock in the price of their grain, helping them manage their future costs and revenue. End users of grain such as flour millers are also exposed to the risk of high grain prices. They need to manage their gross margin, which is the difference between buying from producers and traders at uncertain and volatile prices and selling to end retail users at fixed prices. The futures price helps them lock in this price and provides certainty.
So why grain futures on the ASX? The ASX has said that industry participants asked for a contract to be designed for the local market. Listing such contracts helps both the local domestic producers and the ASX as it diversifies asset classes and trading opportunities for investors.
Traders and speculators may take a position on the grain market and use futures to make money on the price of grain. A trader may be exposed to the risks of both high and low prices. Using futures, a trader can take a position in the grain market without ever owning any grain.
So why trade futures if you have no interest in the grain? Though this contract is not designed for the small retail market at this stage, traders and industry participants use it. It allows you to hedge or trade in another market that usually you would not have ready access to. It helps grain producers offset some of their risk in a volatile market. For example, if you have a view that due to drought you wanted to take a position in wheat because you thought the prices would go up, you could go out and buy the wheat (if you knew where and how) and then transport, store and insure it. However, with the futures contract these matters are all taken care of. You can still take a position but not actually own the physical product.
If you believe that wheat prices are due to fall in the near future you can make money by selling what you don't have. By taking a short (sell) position on the wheat future you can put yourself in a position to take advantage of a fall in the price of wheat by selling the futures and looking to buy the futures contract when the price falls. In essence you can sell what you don't own.
Futures also allow you to take advantage of leverage because when you trade a futures contract your initial outlay is only a small percentage of the value of the contract. If the market moves in your favour, the percentage returns you make from trading the futures contract will be significantly higher than the move in the underlying index. This makes futures an ideal vehicle for investors looking to take on large trading positions for a comparatively low capital commitment.
Traders should note, however, that while potential gains are magnified by using leveraged instruments such as futures, so too are potential losses. Using futures to speculate on share price movements involves significant risks, as well as offering the potential for high returns.
Opening your account
Before you can start trading futures, your broker will require you to:
enter a client agreement
sign a risk disclosure statement
open a futures account
Your broker will usually ask you to provide a cash deposit before you can begin to trade.
Under ASX business rules, your broker is also required to make enquiries about your financial position. The broker must make enquiries to learn your investment objectives, financial situation and particular needs, and maintain a record of this information.
The client agreement sets out the terms and conditions that govern the relationship between you and your broker with respect to futures transactions. As part of the agreement you acknowledge that:
you have read and understood the risk disclosure statement
your broker may call on you to provide cash or security as the broker considers appropriate
you are subject to ASX's business rules
You will be required to complete and sign a client agreement form before trading in futures, even if you already have a client agreement for options in place with your broker.
You are also required to sign a new client agreement form if you change to another broker for your futures transactions.
Settlement requirements for trading futures are strict.
You must pay any margin calls by the time stated in your client agreement.
Under ASX business rules, this can be no longer than 24 hours after being called. Note also that while you may cover your initial margins with collateral, variation margins must be paid in cash.
Given these requirements, you may choose to open a cash management account with your broker to avoid any undue delays in the settlement process.
ASX business rules give your broker wide powers, including the ability to close out contracts if you fail to pay or provide the necessary security.
