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How Money Flows on a Futures Tranaction

Cold, hard cash is the lifeblood of the futures market. Since delivery of the grain is not required, money is the required “commodity” in the absence of the cash commodity.


The cost (commission) to execute a trade at a futures exchange ranges from 59 cents to $150 per 5,000-bushel contract. The typical “full service” commission is $75 per round turn (buy and sell). The commission on mini-contracts (1,000-bushel contracts) is about half as much per contract, but three times more per bushel. The variance in the commission amount is due to brokerage firm policies, the amount of service you request to receive from your brokerage firm and your broker, the quantity of contracts you trade, etc.


Commissions and small regulatory fees are deducted from your brokerage account when incurred, which is when you initiate and close a transaction.


A hedge trader must provide and maintain a money deposit in his trading account to show he has the financial where-with-all to withstand the risk of financial loss of futures trading.


That required deposit is about 25 cents a bushel on corn, 35 cents on wheat, and 50 cents on beans at this time. That required deposit amount is called margin.


The margin money in your brokerage trading account is yours, but it is tied up to “back” your futures trade.


That margin requirement can be changed by the exchange and/or the brokerage firm when the value and the volatility of the commodity changes substantially. That might be two or three times in a “wild” year, or it could be two or three times in one month.


The margin required by the futures exchange is called the “exchange margin” requirement.


The margin required by the brokerage firm is called the “house margin” requirement. A brokerage firm can set house margins at whatever they want. In 1975, the corn initial margin was $5,000 per contract at Merrill Lynch, but $300 per contract at Stotler.


Most agricultural-oriented brokerage firms have house margin requirements the same as exchange minimums.


If you want to set yourself apart from the masses, call a brokerage firm and ask if their house margin is more than the exchange margin. You will blow their socks off! You are not supposed to know those kinds of things!


Definitions:


Initial Margin:


The amount of money which must be deposited into your futures account to initiate a futures position.


Maintenance Margin:


The minimum amount of money required in your brokerage account to maintain a futures position. When the account balance reaches the maintenance margin amount, the account must be restored to the initial margin balance.


Margin Call:


When your broker calls you to add more money to your brokerage account because your account balance is less than the maintenance margin requirement.


For Minneapolis Hard Red Spring Wheat futures, the hedge margin for September, 2019, contract is $1050 per 5,000-bushel contract, but $1365 for speculators. Speculators are futures traders who do not have a cash wheat position to back their futures position.


The maintenance margin for hedgers at the Minneapolis Grain Exchange for Hard Red Spring Wheat is $1050 for both hedgers and speculators.


So, you decide you want to hedge in your own trading account 10,000 bushels of Hard Red Spring Wheat. That will be two 5,000-bushel contracts. The initial margin is $1050 per contract. So, you must deposit $2100 in your brokerage account, which, let’s say is exactly the amount you deposit. You are always encouraged to deposit more than the minimum.


NOW HEAR (READ) THIS:


The price change of the futures is added to or subtracted from every futures trading account every day!


Say What?


Let’s say you short (sell) Minneapolis Hard Red Spring Wheat at $5.88 about noon today. The “settlement” price for each day is determined about 20 to 30 minutes after the close of trading. Let’s say today’s settlement is $5.87.


What happens?


You deposited 21 cents per bushel initial margin in your trading (brokerage) account.


You sold (went short) wheat at $5.88 today.


The market settled at $5.87 today. Are you making money or losing money? If you do not know, go back and read the definition of what “short” means!


The exchange will deduct one cent a bushel from the account of the trader who bought 10,000 bushels of wheat at $5.88 and put one cent a bushel in your trading account because you are short wheat at $5.88 and the settlement was $5.87.


Thus, you now have 22 cents a bushel in your margin (brokerage) account, one cent more than required.


Let’s say tomorrow the price of September Hard Red Spring wheat settles at $5.81, down 6 cents for the day. Six cents will be deducted from the margin account of every trader long September spring wheat and added to every trading account short September spring wheat.


You now have 28 cents in your margin account, but you are only required to have 21 cents. After just two trading days, you have a hedge profit of seven cents on 10,000 bushels… $700!


Let’s say over the next month, September spring wheat works lower and settles at $5.50 sometime in February. Your margin account now has the 21 cents initial margin plus 38 cents of profit (sold at $5.88 minus current price of $5.50), which came from the accounts of those who are long September Spring wheat. So far, so good.


Weather turns nasty in March, and the forecast looks like more bad weather is ahead. The futures begin a rally. Each day the market settles higher, money is deducted from your margin account. Let’s say on April 29, September spring wheat settles above your sold price ($5.88) for the first time. After the deduction for that day, you have less than 21 cents per bushel in your account. Your broker calls you and says, "send money." That is a margin call.


The amount you must send is whatever it takes to bring the margin account back to the initial margin amount as of that day’s settlement.


In this example, the hedge initial margin and the maintenance margin were the same, $1050 per contract. If the initial margin had been $1350 per contract and the maintenance margin $1050 per contract, then you could lose $300 per contract before you received a margin call to bring the balance back to the initial margin of $1350 per contract.


You meet (pay) the margin call and maintain your short position. Let’s say the weather changes for the good of the wheat crop, wheat futures price return to a down trend, and by the end of August it is $5.20. You have 68 cents of profit ($5.88 sold minus $5.20 current price) in your trading account plus the amount of money you deposited to initiate the trade and any additional money you deposited to maintain the position. There was a commission charged the day the trade was initiated, and another commission will be charged when the position is liquidated.


You price the wheat at the elevator and liquidate your hedge the same instant. You tell your broker to send the money you made. If you do not expect to trade for a while, have him send all the money.


Note: as you accumulate more money in your trading account through the market moving in a profitable way for your position, you can withdraw that excess amount. Is that meaningful?


If you hedged 50,000 bushels of beans at $14 in June and the price declines to $11 by mid-August, you will have $150,000 excess funds in your hedge account. If the hedge was at the elevator in the form of an HTA or forward contract, you would not be entitled to that money until you delivered the beans. By the same token, if you sold beans at $14 in your own account and the price went to $17, you would be required to add a total of $150,000 in margin by the time the market reached $17. If the hedge was at the elevator, the merchandiser would be required to meet that $150,000 margin call.


There may be a minimum deposit required to maintain the account active.


Questions?


How Money Flows on a Futures Transaction
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