Futures Education

Agriculture

Before we go too far into the agriculture section, it is important to note that we will lump meats, agriculture and textiles all into the same category. As you dive deeper into commodities you will learn more defining aspects that would warrant differentiation. In fact, many texts will separate them into separate discussions, but in our effort to serve a general learning process, we will keep them combined.
A crucial link in the financial food chain, it may be argued that the United States wouldn't have become the agricultural super power it has without the futures markets.
These agriculture contracts help spread shipments throughout the year, so buyers and sellers know they always have a market for their product. Whether it's wheat, oil, or gold, all commodities experience times of increased demand. Futures give traders a way to prepare for that demand and price ahead accordingly.
Agriculture is less popular in modern futures markets than it has been in the past. During the first seventy years of futures trading, agriculture was the dominant product. It is in the agricultural markets that the futures industry cut its teeth and gained prominence as an independent financial market.
There are a few concepts unique to Agricultural products of which you should be aware.
The first is seasonality, or the measurement of short-term draws on an agricultural product. For example, during the summer months, the demand for certain cuts of beef that can be grilled outside will increase, reducing supply and increasing prices. Similarly, in the grain market, supplies are generally full in the fall and slim in the spring.
Likewise, in crop products, the planting season, pollination or growing season must be understood in order to accurately forecast grain prices.
There are some general rules to understand in the meat market. First, January through March tend to be bullish for feeder livestock prices. April through August is generally a flat or bearish period. September through December prices tend to perform relatively well, although not as good as January through March.
Second is cycle analysis. The agricultural markets go through several cycles where herds or stocks are built up and subsequently sold off. When farmers and ranchers increase the stock (grains and animals) in their herds or silos it's called the accumulation phase of the cycle. When they thin their stock, it's called the liquidation phase.
In the meat industry, the time that passes from accumulation to liquidation is called the livestock cycle. In the past, the cycle for cattle was approximately 10-12 years. For hogs, the cycle was 3-4 years. The actual length of the cycle is measured trough to trough (not a feed trough, but a low point in herd inventory). The cycle is largely dependent on the animals' ability to reproduce.
Before you begin trading agricultural commodities it is important to have an understanding of the fundamentals of the particular sector and market in which you are trading. For example, you would need to know about growing and harvesting seasons, geopolitical risks in the growing area (including local politics), and how weather affects the crop.

Low liquidity

Agriculture commodities have a few characteristics that are unique to this segment of futures trading that may affect prices from a structural standpoint as well. First, agricultural commodities are not traded as much as interest rate or stock index futures. This can leave you exposed to wild price fluctuations and liquidity problems. Second, low liquidity can lead to price gaps where price seems to "skip" a significant level of price quotes. In simpler terms, prices can be trading at $8.75 one moment and gap up to $9.25 the next. Finally, the limited liquidity can widen the spread between the bid and ask price, making it a challenge to make a profit in the short term.
With that let's discuss some of the major contracts listed in the agriculture sector of the commodities market.

Grains

Grains and soybeans are essential to food and feed supplies. The major futures contracts in this category are corn, soybeans, soybean oil, soybean meal and wheat. Grain prices are especially sensitive to weather conditions in growing areas at key times during a crop's development and to economic conditions that affect demand. Because corn is integral to the increasing popularity of ethanol fuel, the energy markets and outlook for fuel demand also affect the grain markets.

Corn

The single greatest use for corn is as feed for livestock including cattle, hogs and poultry. It is called feed corn and is not typically the kind of corn you eat on summer picnics.
Corn and corn by-products are processed into many everyday food items such as corn oil used in margarine, cornstarch used in gravy and corn sweeteners used in soft drinks. Non-food uses include alcohol for ethanol, absorbing agents for disposable diapers and adhesives for paper products.
Corn is traded on the Chicago Board of Trade. It is the most active commodity among grain traders and is the major crop grown in the United States. U.S. farmers grow about 50% of the world's corn supply and roughly 80% of our production is consumed domestically.
Like most grain products, corn has a seasonal price pattern. Price lows are set at harvest when supplies are greatest. Price tends to advance from these levels to a high in the spring, just before the new crop is planted. Weather also plays an important factor; in fact, it is widely known that the fate of the corn crop in the United States depends on whether it rains in the Corn Belt in June and July.

Corn futures contracts trade in units of 5,000 bushels. The minimum price fluctuation is also $0.0025 per bushel and the tick value is $12.50.
Additionally, a CBOT mini-sized Corn futures contract of 1,000 bushels (about 25 metric tons) is available for trading. The minimum price fluctuation is $0.00125 and the tick value is $1.25.

Soybeans

Soybeans are crushed to obtain their oil and meal. Of the two, meal is considered the more valuable product, and prices are more volatile since it cannot be stored for a long period of time. Soybeans are one of the most popular oilseed products in the world, with a seemingly limitless range of uses from food to feed to industrial products.
For example, whole soybean products are especially appreciated in Asia and among global natural-food devotees. Soybeans provide the basis for low fat sources of protein such as tofu, miso and soymilk. Many publications are printed with soy ink, which has become an increasingly popular alternative to petrochemical-based inks. Soybeans and the soybean by-products (soybean meal and soybean oil) have a special economic relationship from production to processing to marketing and consumption.
The supply of soybean meal is determined by the output of processing facilities. Since soy must be crushed to extract the valuable protein, the supply is dependent on the "crush margin," or the profitability of crushing beans. If beans are relatively inexpensive, crushers will continue to operate, and meal prices will drop.
Demand for meal depends on the price and availability of substitute products, the level of soy stocks, and the rate of disappearance, and most importantly the number of high protein feed consuming animals in the U.S. and other nations around the world.

Soybean futures contracts trade in units of 5,000 bushels. The minimum price fluctuation is also $0.1 per ton and the tick value is $12.50.
Soybean Meal futures contracts trade in units of 100 tons. The minimum price fluctuation is also $0.0025 per bushel and the tick value is $10.00.
Additionally, a CBOT mini-sized Soybean futures contract of 1,000 bushels (about 27 metric tons) is available for trading. The minimum price fluctuation is $0.00125 per ton and the tick value is $1.25.

Wheat

Wheat futures are traded on three major exchanges: the Chicago Board of Trade, the Kansas City Board of Trade and the Minneapolis Grain Exchange.
The most popular wheat product is winter wheat, which is planted in the fall and harvested in June and July. Wheat that is planted in the spring and harvested in the fall is called spring wheat.
There are three basic yet different futures contracts that constitute the majority of wheat futures. Each contract trades on a different exchange:

The most popular is the Chicago Board of Trade No. 2 Soft Red Winter wheat, which is used in mills to produce flour for crackers, cookies, cakes, and pastries. Also harvested in the summer, its new-crop month is July, and its primary growing areas include Ohio, Missouri and Illinois.
The second is the Kansas City Board of Trade Hard Winter Wheat contract, which is the major U.S. wheat export. The most prominent wheat grown in the U.S., this is the wheat for which Kansas is famous, and it is often blended with HRS wheat to produce bread flour. It is harvested in the summer, and the new-crop month is July.
The third is the Minneapolis Grain Exchange Hard Red Spring Wheat, which is the only major wheat class seeded in the spring. This means the crop is harvested later than wheat seeded in the fall, and September is its new-crop month.
The primary fundamental factors affecting this market are as follows:
Often, a cool, wet growing season increases the chance for crop disease and suppresses the protein potential of the wheat, reducing the amount of quality wheat available for milling. On the other hand, a hot and dry summer encourages protein development but also potentially reduces yields. Low protein or quality issues with winter wheat typically will increase demand for spring wheat.
Corn, soybean and winter wheat prices often influence the direction of spring wheat prices. In addition, foreign exchange, energy and other commodities can influence wheat supply and demand. For example, a strong dollar means U.S. wheat costs more, potentially slowing foreign purchases of U.S. wheat and depressing prices.
Changes in government policy influence the amount of acres planted to various crops in the U.S. For example, a change in policy that benefits corn may shift acres away from wheat.
Much of the U.S. wheat crop is exported to countries including Japan, Italy, Taiwan and the Philippines. The level of overseas demand from year to year strongly influences spring wheat futures prices.
The Chicago Board of Trade No. 2 Soft Red Winter Wheat futures contracts trade in units of 5,000 bushels. The minimum price fluctuation is also $0.025 per ton and the tick value is $12.50.
The Kansas City Board of Trade Hard Winter Wheat futures contracts trade in units of 5,000 bushels. The minimum price fluctuation is also $0.025 per ton and the tick value is $12.50.
The Minneapolis Grain Exchange Hard Red Spring Wheat futures contracts trade in units of 5,000 bushels. The minimum price fluctuation is also $0.025 per ton and the tick value is $12.50.

Meats

Commodity futures on meat, or livestock, include live cattle, feeder cattle, lean hogs and pork bellies. These contracts are all traded at the Chicago Mercantile Exchange. Their prices are affected by consumer demand, competing protein sources, price of feed, and factors that influence the number of animals born and sent to market, such as disease and weather.

Cattle

The U.S. cattle and beef industry is big business - estimated at $71 billion in 2006 - and risky. Cattle are fed on grass and/or corn, and are placed on feed at a weight of about 700 pounds and marketed some 8 to 10 weeks later at weights of 1,000 to 12,000 pounds. Most cattle production comes from areas close to feed grain production due to economies of scale and limiting the need for transportation.
Any number of factors, including weather and disease, can lead to an increase or decrease of supply and demand for livestock. From a larger perspective, consumer preference also plays a role in the average per capita consumption, and demand has remained steady for the last twenty years.
As mentioned earlier, cattle have a long-term price production cycle - often in excess of 10 years. During this time, the number of animals ready for slaughter respond to changes in the prices of cattle and feed, generally rising when cattle prices remain relatively high and falling when cattle prices are relatively low.
There are two primary trading instruments in cattle commodities: live cattle and feeder cattle.

Live Cattle is the most traded contract. Live Cattle futures contracts trade in units of 40,000 pounds of cattle. The minimum price fluctuation is .00025 per pound and the tick value is $10.00.
Feeder cattle futures contracts trade in units of 50,000 pounds. The minimum price fluctuation is .00025 per pound and the tick value is $12.50.

Pork

Now it's time to set the record straight. Pork bellies are not actually the belly of a pig - despite the common misconception. It is essentially uncured bacon and is a primary means of purchasing pork for many pork-derived products.
The U.S. pork industry's total sales were greater than please replace the following stat with the sales for a more current year $97 billion in 2005 and have experienced an average daily volume growth of 363% since 2003. Any number of factors, including weather and disease, can lead to an increase or decrease of supply and demand for livestock. CME Group Pork futures and options serve commodity producers and users seeking risk management and hedging tools, alongside funds and other traders looking to capitalize on the extraordinary opportunities these markets offer.
Demand for pork, like cattle and other grains, is relatively inelastic. When pork prices rise, the general demand for pork remains relatively constant. As a consequence, the principal price factor for pork is supply. Small changes in pork supplies can have significant impact on price. Many pork traders look at two important relationships to forecast prices: the hog-to-corn relationship and the hog cycle, which is a relatively short 3-4 year cycle.
There are two primary trading instruments in pork commodities: lean hogs and pork bellies.

Lean hog contracts are among the most actively traded. Lean hog futures contracts trade in units of 40,000 pounds. The minimum price fluctuation is .025 per pound and the tick value is $10.00.
Pork belly futures contracts also trade in units of 40,000 pounds. The minimum price fluctuation is .00025 per pound and the tick value is $10.00.

Foods and Fibers

Commodity futures in the foods and fiber sector include cocoa, coffee, sugar, cotton and orange juice. These contracts are all traded at the Inter-Continental Exchange, ICE, formerly known as the New York Board of Trade.

Cocoa

The Cocoa contract is the world benchmark for the global cocoa market. Cocoa's transition from a luxury item to a staple commodity in the world's marketplace made its price the dominant concern for those in the production and consumption chain. As Cocoa's popularity grew, additional pressures on supply and demand made its pricing less predictable.
Chief among the contributing factors to Cocoa's pricing instability are its complex growth and harvesting techniques. A surplus or shortage of supply can cause sharp price fluctuations long before the cash market can adjust.
Due to Cocoa's seasonal demand cycles and concentrated production sources - limited to just eight countries serving the global demand - the cocoa market is subject to a high degree of volatility, which presents attractive hedging and trading opportunities for cocoa traders around the world.

Cocoa futures contracts trade in units of 10 metric tons. The minimum price fluctuation is $1.00 per metric ton and the tick value is $10.00.

Coffee

The ICE Futures U.S. coffee futures market was established in 1882 as merchants and traders created the Coffee Exchange of New York to bring order to pricing in the industry. When a commodity such as coffee assumes a growing position in the global economy, it also invites vulnerability to major price shocks, and increased hedging and trading activity.
Volatility in the coffee market has been historically greater than that of other soft commodities markets, often triggering increased levels of activity from both hedgers wishing to lay off risk and financial participants willing to take on those risks. The result is more bids and offers, providing a critical mass of liquidity, hedging and pricing opportunities.

Coffee futures contracts trade in units of 37,500 pounds. The minimum price fluctuation is 5/100 of a cent per pound and the tick value is $18.75.

Cotton

Cotton futures have been trading since 1870 at New York's original futures exchange. The ICE Futures U.S. cotton options market, opening in 1984, represents one of the most active agricultural options markets in the world. This universal fiber dates back to over five thousand years ago and served as one of the first "currencies" of world trade.
Raw cotton fiber is produced and consumed globally, and has certain qualitative characteristics and quantitative elements. These attributes allow cotton to be standardized for trade in futures markets. The continuity of the cotton futures market relies heavily on a contract's ability to reflect cash market conditions and practices.
Cotton's worldwide appeal and vulnerability to unforeseen natural and man-made events raises the economic stakes for this commodity, attracting hedgers, speculators and risk managers to what is one of the most actively traded and highly liquid markets in the world.

Cotton futures contracts trade in units of 50,000 pounds. The minimum price fluctuation is 1/100 of a cent per pound and the tick value is $5.00.

Frozen Concentrated Orange Juice

Though a number of factors such as processing capacity, dietary trends and consumer price sensitivity can impact the price of orange juice, the major factor in pricing has been and continues to be weather. Hurricanes, frost or even drought conditions in Florida and Brazil - two major citrus producers - can have a major impact on the market.
Weather sensitivity, when combined with the competitive global juice and beverage market, and a rapidly-changing supply and demand picture, makes the price of orange juice extremely volatile. Since the great majority of oranges grown in the U.S. are turned into frozen or fresh juice, the price of orange juice is important. The ICE Futures U.S. FCOJ market provides critical risk management tools to an industry at extra risk when the wind blows or the frost forms.

Frozen Concentrated Orange Juice futures contracts trade in units of 15,000 pounds of orange juice solids. The minimum price fluctuation is 5/100 of a cent per pound and the tick value is $7.50.

Sugar

Sugar is one of the world's ten largest agricultural futures markets, the world looks to ICE Futures U.S. each day to price this vital commodity. For centuries, sugar has been a highly valued and widely traded commodity. What was once a luxury has evolved into a moderately priced and widely traded neccessity. Produced in over 120 countries and consumed globally, sugar turns up everywhere from your coffee cup - as a food additive - to your gas tank - as the fuel additive ethanol.
A large set of commercial market participants, including producers, exporters, candy manufacturers, trade houses and a diverse set of institutional participants underscores the importance of the sugar futures and options markets, ensuring highly efficient pricing and continuous liquidity.

Sugar futures contracts trade in units of 112,000 pounds of sugar. The minimum price fluctuation is 1/100 of a cent per pound and the tick value is $11.20.

Unique Commodity Strategies

In addition to the previously mentioned general strategies for trading futures - namely, speculative trend trading and hedging techniques - the commodity industry also incorporates unique spread strategies.
Any combination of futures contracts and/or months may constitute a spread in the commodities market. A spread trade involves the simultaneous buy and/or sell of different futures contracts. There are two basic types of commodity spreads:

Intra-market Calendar Spreads

The simultaneous purchase and sale of a futures contract in any one commodity with two different expiration months.

Inter-market Spreads

Inter-market spreads consist of the simultaneous purchase and sale of more than one economically related futures contract heating oil and gasoline, natural gas and electricity or propane. In the petroleum markets this is known as "trading across the barrel." The crude oil/heating oil and crude oil/gasoline differentials are known as "crack spreads."
Spreads executed on the exchange are treated as a single transaction for the purpose of determining your overall margin requirement. Since a spread is created by the simultaneous buy and sell of two different futures contracts, the trade is said to have two "legs" or sides - the buy side and the sell side. For margin purposes, the minimum margin requirement takes into account that the risk on one leg of the spread is generally reduced by the risk of the other leg of the spread.
While there are many types of commodity spreads, two are worth mentioning due to their popularity in the commodities market: the "crack" spread and the soybean "crush."

Crack Spread

A crack spread is the simultaneous purchase and sale of a crude oil futures contract and a gasoline or heating oil futures contract in one or more months at a stated price differential. It represents the theoretical profit (or loss) between the cost of crude oil and the price realized in the market for the refined products. The crack spread gets its name from the "cracking" of crude oil at a refinery into products.
The use of crack spreads have proven to be particularly useful since crude oil and product prices can fluctuate dramatically in response to extreme weather conditions or political crises, sometimes generating high margins for refiners and marketers, but at other times severely squeezing their profitability.
A futures crack spread is treated as a single transaction for the purpose of determining a market participant's margin requirement. The minimum margin requirement takes into account that the other leg of the spread generally reduces the risk on one side of the spread.
In a crack spread transaction, the number of crude oil contracts must equal the total number of product contracts. Crack spreads often reflect real world refining ratios. A popular spread is the 3:2:1 spread which uses the prices of three barrels of crude, two barrels of gasoline, and a barrel of heating oil to determine the spread.
Similar strategies involving other energy products such as natural gas and propane the fractionation spread, and natural gas or coal and electricity the spark spread, are calculated on a British thermal unit-equivalency basis.

Soybean "Crush"

The Soybean Crush refers to the physical process of converting soybeans to soybean by-products (soybean meal and soybean oil). It is a value calculation used in both the cash and futures markets for soybeans and soybean by-products and it is also a trading strategy.
The crush involves the purchase of soybeans and the sale of soybean meal and soybean oil. The reverse crush involves the sale of soybeans and the purchase of soybean meal and soybean oil. The crush spread is a monetary value quoted as the difference between the combined prices of the soybean by-products and the price of the soybeans.
This is called Processing Margin (GPM) when using cash market prices and is referred to as the Board Crush when using futures market prices. As a strategy, soybean processors will use the board crush to manage the price risk associated with buying soybeans and selling the soybean by-products. There are also speculative opportunities, as the crush spread relationship may vary over time.

Wrap–up

You have covered a lot of material and have been shown a lot of futures instruments and strategies. However, this is not an end all be all solution to futures. In fact we have just barely touched the surface. Before making live trades with these products, it might be a good idea to practice first with virtual trades on a simulated trading program.
With some practice and discipline, you can make exciting things happen in the futures market.