A futures market, like any market, is a place where buyers and sellers meet in order to transact. For every buyer, there is a seller and for every seller, there is a buyer. Matching these two together so that a trade can be consummated requires the participation of a host of individuals and organizations, each having specific roles, which in the aggregate make the futures market the efficient mechanism that it is today. Throughout this section, reference is made solely to the futures market only for convenience and simplicity of presentation. The market for options on futures is structured in very much the same manner.commodity futures broker, futures trader, commodities futures trading, financial and commodity futures markets, paper trading, full service broker assisted accounts.
The Futures and Options Exchange
The central player of a futures market is a futures exchange. A futures exchange is a meeting place where futures contracts are bought and sold. Trading occurs against a background of regulatory surveliance and guidelines from the exchange itself and from the Commodity Futures Trading Commission (CFTC). Each exchange has its own list of products that it trades, and each product is traded in a designated futures trading pit. A trading pit is an area of floor, usually round with concentric steps leading down into the center. The trading pits are each divided into a number of sections designated for trading in particular contract months. No trading may occur outside a contract's assigned pit, nor is trading permitted at any time other than during those hours which have been designated by the exchange. (Some exchanges also use automated trading facilities or computer networks which serve as trading pits.)
In addition to providing the market place for trading futures and regulating trading within its pits, futures exchanges also design and specify their futures contracts. Futures contracts are very specific in terms of the quality and quantity of goods underlying the contract. You may have wondered who determines these specifications. The answer is the futures exchange. Working with participants in the industry such as traders, fund managers and natural hedgers, a futures exchange designs a contract to meet the greatest need. If the exchange succeeds, it will have designed a futures product that many players can use or trade, and volume in the futures will grow. Contract specifications can sometimes be changed by the exchange, and is usually done to keep the contract viable. For this reason, it is a good idea to periodically check the specifications of the contracts that you trade or want to trade.commodity futures broker, futures trader, commodities futures trading, financial and commodity futures markets, paper trading, full service broker assisted accounts.
The Futures Broker
Buying or selling a futures contract or an option on a futures contract can only be done in one place: the trading pit on the floor of a futures exchange. To stand in a trading pit, you need to buy an exchange membership, pay annual dues, and register with various regulatory agencies. Naturally, few people would trade futures if it required that they stand in the trading pit. To solve this problem, in steps the futures broker. Your broker acts as a communication link between the trading pit and you, taking orders from you, the customer, and executing them in the futures pit.commodity futures broker, futures trader, commodities futures trading, financial and commodity futures markets, paper trading, full service broker assisted accounts.
This is the traditional path that a futures order takes as it passes through the system:
- You, the customer, decide to buy or sell a futures contract, perhaps based on information originating from us.
- You phone your order to the futures order desk of our Futures Commission Merchant (FCM).
- The order desk relays by telephone your order to the phone clerk on the exchange floor.
- The clerk writes the futures order, time stamps it, and delivers it to the executing floor broker in the trading pit. If a market order, the order is executed. If any other kind of order, it is placed in a "deck" along with other orders ready to be executed if triggered by price movements.
- Once executed, the floor broker informs the clerk who informs the order desk who, in turn, informs you. You now have a futures position.
- The FCM prepares a trade confirmation report and mails it to you.
- The FCM marks-to-market your futures position against the margin in your trading account.
As you can see, there are several players, each having different roles, who are involved in the process. Despite the steps involved, the process has become very efficient - orders can often be executed within a minute or two while you wait on the phone.
You may wonder why a futures broker requires an FCM to complete this process. By law, futures brokers do not have the authority to take customer funds and hold them in deposit. Only an FCM can do this. For this reason, a futures broker needs to team up with an FCM in order to provide order execution services to its customers.commodity futures broker, futures trader, commodities futures trading, financial and commodity futures markets, paper trading, full service broker assisted accounts.
The Futures Commission Merchant
The Futures Commission Merchant (FCM) is responsible for holding customer funds of the margin account, clearing the futures trade, and performing all back-office recording functions such as marking-to-market your futures account, sending trade confirmations and account summaries, and year-end tax forms. Customers who open a futures trading account deposit their margin funds at an FCM.
The Clearing Corporation
The clearing corporation guarantees the performance of every buyer and seller of a futures or options contract. In a literal sense, it stands as a buyer to every seller and a seller to every buyer. As a futures trader, that means that you don't have to worry about any default of a futures counterparty. For instance, say that you purchase several Swiss franc futures and the price goes up so that you have accrued a $4,500 profit. Whoever sold those futures contracts (and there is a seller for every buyer, and vice-versa) has incurred a loss of $4,500. What happens if that person can't pay? Do you sacrifice your profit? The answer is "NO". The clearing corporation guarantees the transaction. The clearing corporation's elimination of such counterparty credit risk provides a great benefit to the futures and options markets. You may wonder how the clearing corporation does this. The answer lies in the margin deposit that you and every other futures trader must make before trading any contract. This margin is available to the clearing corporation and, together with other reserve cash and various protection funds, are used to cover any customer default. A clearing corporation is composed of clearing members, most of which are large FCM's. It is a mark of distinction for an FCM to be a clearing member. commodity futures broker, futures trader, commodities futures trading, financial and commodity futures markets, paper trading, full service broker assisted accounts.
Regulation of the futures market
All futures industry-related operations, including exchanges, brokers and FCMs are regulated and licensed by the Commodity Futures Trading Commission (CFTC), a federal agency with jurisdiction over the United States commodities markets. The CFTC regulates in conjunction with the National Futures Association (NFA), the industry's only national association. The primary purpose of the NFA is to ensure, through self-regulation, high standards of professional conduct and financial responsibility on the part of the individuals and organizations that are its members: Futures Commission Merchants, Introducing Brokers, Commodity Trading Advisors, Commodity Pool Operators, and Associated Persons. In connection with its regulatory responsibilities, the NFA conducts periodic audits of its members' financial and other records, monitors sales practices and provides a mechanism for the arbitration of futures related disputes between NFA members and the investing public.
Information on the NFA and CFTC can be directed by post to:
National Futures Association
200 West Madison Street
Chicago, IL 60606
(800) 621-3570
Commodity Futures Trading Commission
2033 K Street Northwest
Washington, D.C. 20581
(202) 254-8630
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Fees
Described above is a network of individuals and organizations which exist to serve you, the futures trader. These participants require payment for their services. Payment takes the form of commission and other fees which are expressed as a fixed dollar amount per round-turn contract traded. A round-turn transaction means a completed and closed transaction - a buy followed later buy a sell, or a sell followed later by a buy.
The clerk and floor broker receive a transaction fee for executing the customer's order. Fees are also paid to the futures commission merchant, the clearing corporation, the National Futures Association (NFA) and the futures exchange on which the contract trades. Taken together, these fees can range anywhere from $25 per contract for discount brokers who offer very little if any customer services, to over $95 per contract for full-service brokers. Additional services provided by full-service brokers consist of market commentaries, identification of trading opportunities, and trading tips or advice.
In addition to its clearing and processing fees, the FCM typically receives interest income on customer cash margin deposits; the customer receives no interest income. However, those customers who typically hold considerable excess margin in their trading account can use some of this money to purchase a treasury bill which receives interest income.commodity futures broker, futures trader, commodities futures trading, financial and commodity futures markets, paper trading, full service broker assisted accounts.
