economics of futures trading for commercial and personal profit chapter2

7/28/2019 Economics of Futures Trading for Commercial and Personal Profit Chapter2

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C H A P T E R

Exchanges and Commodities

The current scope of futures trading can best be seen by reading the commodity pages of leading financial newspapers. One section lists the exchangesand the prices of the various delivery months of the commodities traded. Thebreadth and diversity is imm ediately appa rent; there are numerous exchanges, alarge number of commodities, and several delivery months are listed for eachcommodity. Prices are indicated for the open, high, low, close, previous close orchange in price from the preceding day, and usually the life of the contract highand low. On focusing in on a section one notes:

C H I C A G O M E R C A N T I L E E X C H A N G EFrozen Pork Bellies

Feb.Mar.M ayJulyAug .

Open70.0569.0068.5067.7564.85

High70.7769.5069.1068.4565.45

Low68.0266.6066.1565.7062.70

Close68.1066.7066.2565.8063.00

Prev.Close70.0268.5068.2067.7064.90

Life of Contr.High Low104.10 55.25100.15 58.2096.50 63.3094.95 64.5092.45 62.25

(O n a typical day, in a newspaper offering the most complete coverage available, there are about 50 such items regarding North American markets and adozen or more regarding European m arkets.)W ha t does this mean ? Contracts for the delivery of pork bellies in the severalmonths listed were traded on the Chicago Mercantile Exchange at the pricesand within the price ranges shown. These are futures contracts in contrast toforward contracts. The distinguishing difference between the two kinds ofcontracts is that futures contracts are traded under the rules and subject to theregulations of the exchange which is chartered, designated and licensed for thepurpose of trading in futures contracts. They are not prices of trades in physical

Commodity Research Bureau 1977

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10 Descriptionbell ies but rather prices at which contracts for the eventual exchange of bel l ieswi l l be made. Futures cont racts are s tandardized agreements made on organizedexchanges .

A pork belly is a piece of flesh peeled from the lower central section of ah o g ' s anatomyone from either s ide. Nearly al l bel l ies are eventually s l icedinto the familiar product , bacon. A contract consis ts of 36,000 pounds of 10 to14 po un d bel lies of s tanda rd grad e. On the day that the quota t ion w as tak enfrom, there we re 4 ,860 contracts t rade d. Th ere w ere 2 ,667 for Feb ruary del ivery ,1,045 for March, 499 for May, 488 for July, and 161 for August . The pricesshown are cents per pound. The trading is in increments of .025 cents perpound so that the quotat ions shown that end in 7 or 2 as 70.02 should have a5 ad ded to 70.025 . Price f luctuations repre sent sub stantial cha nge s in c ontractvalue. One cent per pound on 36,000 pounds is $360 and .025 cents is $9.00.The change in the February belly price from the close to close shown is $693.00per cont ract . The range for the season unt i l the day quoted was $17,586. Therange to date was a f luctuation of 61 percent of the median value. The range inmoney value was a substantial amount, but 36,000 pounds of bacon is a subs tant ia l amount , too.

A focus on each of the other i tems yields similar results . W h e a t is t rad ed onseveral exchanges in contracts of 5,000 bushels for del ivery in July, September,December , March, and May. The pr ice i s dol lars per bushel , and f luctuat ionsare quoted in 1/4 cent per bushel . A contract of soybean oil is 60,000 pounds, theprice is quoted in cents per pound, the minimum fluctuation is .01 cents , and theexchange i s the Chicago Board of Trade. Al l of the quotat ions have some elements in common. They are about prices of commodit ies . The trade is in contracts of s tandardized s ize and quali ty. The contracts involve substantial quantities, and price fluctuate.

E x c h a n g e sA commodity exchange is a voluntary associat ion of people whose businessinvolves, of ten t imes among other things, t rading in commodity futures con

tracts . The older exchanges were chartered by special acts of the legis latures ofthe various s tates in which they were located. The exchanges of more recentor ig in are organized under membership corporat ion laws . Most of the exchanges, the older ones in part icular , developed out of organizat ions for t radingin cash or spot commodit ies . They were associat ions of merchants , organized toformulate ru les and supervise t rading pract ices , hence the names , "Board ofTrade ," "Assoc ia t ion o f Commerce ," "Produce Exchange ," e t c .

The oldes t commodi ty exchange in the Uni ted Sta tes i s the Chicago Board ofTrade. I t s tar ted operat ions in 1848 as a spot market and received i ts charter in1859. Futures t rading was developed a t the Chicago Board of Trade in 1865.


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Exchanges and Commodities 11The New York Produce Exchange was incorporated in 1862 and operated as aspot market. The New York Cotton Exchange was organized in 1870 andincorporated in 18 71. Th e N ew Orleans Cotton Exchange was formed in 1870.The Chicago Board of Trade served as the pattern and pace maker for thenumerous grain exchanges that were established during the second half of the19th century. There was futures trading on some of these. In 1920 1 the following cities were listed as having cereal futures markets: Chicago, Minneapolis,Duluth, Milwaukee, Omaha, Kansas City, St. Louis, Toledo, Baltimore, SanFrancisco, and New York. The cereals traded were wheat, corn, oats, rye, andbarley.The same report described other futures trading: "There is also at Duluth afutures market for the special variety of wheat known as durum. There issimilarly a market in kaffir corn (including milo maize and feterita) at KansasCity. In addition to the food grains, flax futures are traded at Duluth. Toledohas a futures market for the several important kinds of hayseedclover, alsike,and timothy. The New York Produce Exchange has a futures market in cottonseed oil. At New York, also, and at New Orleans are important markets incotton futures. Butter and eggs, prior to the entrance of the United States intothe World War, were traded in through a call for futures on the New YorkMercantile Exchange, the New York Butter and Eggs Exchange, and theChicago Butter and Egg Board. Provisions futures (po rk products) are tradedin at Chicago. This enumeration probably exhausts the list of futures markets inthe United States for this country's agricultural products."Several exchanges for trading in rubber, cocoa, silk, hides and metals wereorganized in the 1920's, mainly in New York. The number of these was somewhat reduced in 1933 when the Rubber Exchange of New York, The NationalSilk Exchange, The National Metal Exchange, and The New York Hide Exchange merged to form the Commodity Exchange, Inc.The exchanges in the United States at which there was futures trading in1975 were: Board of trade of the City of Chicago, Chicago Mercantile Exchange, MidAmerica Commodity Exchange, International Monetary Market(Chicago), Kansas City Board of Trade, Minneapolis Grain Exchange, PacificCommodities Exchange, Inc. (San Francisco), New York Cotton Exchange,Citrus Associates of the New York Cotton Exchange, Inc., Wool Associates ofthe New York Cotton Exchange, Inc., Petroleum Associates of the New YorkCotton Exchange, Inc., New York Mercantile Exchange, Commodity Exchange,Inc. (New York), New York Cocoa Exchange, Inc., New York Coffee andSugar Exchange, Inc.In addition to the active exchanges there are several organized exchanges onwhich futures trading has existed in the past. These a re: Du luth Board of T rade,Memphis Board of Trade, Milwaukee Grain Exchange, New Orleans Cotton

l Federal Trade Commission, The Grain Trade, Vol. V, Sept., 1920.


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12 DescriptionExchange, Portland Grain Exchange, Northern California Grain Exchange,Seattle Grain Exchange, and Merchants' Exchange of St. Louis. Some of theseexchanges have been inactive for quite some time while others have onlyrecently dropped from the active list. Trading on some of the active exchangeshas declined to nearly inactive status. Tra ding is not something that an exchangedecides to have or not to have. The re is trading when someone shows up to tradeand not when the members don't.There are commodity futures exchanges in other countries but it is difficult toidentify and describe them because they operate with different degrees offormality and under various kinds of charters. At some point in the course ofcommerce forward contracts become futures contracts and the line betweenthem is fuzzy. Formalized futures trading as it is conducted on United Statesexchanges is not singularly an American product but it is nearly so. This has notalways been the case. For many years the Liverpool wheat futures market wasvery active and was the dominant pricing influence in the world wheat trade.Futures trading in Germany became so active and attracted so much attentionthat it was banned by law in 1896. Four years later it was clear that the ban didnot cure the evils ascribed to futures trading and the ban was removed.The Winnipeg Commodity Exchange in Canada is an old and significantfutures market. Currently there is trading in oats, barley, rye, flaxseed, rapeseed,and feed wheat futures, the last being a quite recent addition. Prior to WorldWar II, Winnipeg was one of the most important wheat futures markets in theworld. But since World War II a governmental agency, the Canadian WheatBoard, has become the sole wheat marketing organization so that there is nobasis for futures trading in Canada's high quality spring wheat.There are nine separate organizations in London that can be identified asfutures markets although the volume of trading on most of them is small. Thetwo of greatest significance to U.S. trade interests are the United TerminalSugar Market Association and the London Cocoa Terminal Market Association.Business on these two exchanges is now about as large as on their counterpartsin New York.The two markets in Liverpool are the Liverpool Cotton Futures Market Ltd.,and the Liverpool Corn Trade Association.The Bourse de Commerce in Paris conducts futures trading in cocoa, sugar,corn, and soybean meal.Cocoa is a popular commodity for futures trading. In addition to the marketsnoted above, it is traded on Stichting Cocatermijnmarkt in Amsterdam.There are several futures markets in Japan, the most important of which isTokyo Grain and Commodity Exchange. Commodities traded in Japanesefutures markets are various kinds of textile yarn, rubber, sugar, and variouskinds of edible beans. The most important of these commodities is the Azukibeannot so important in a commercial sense but trading is in large volume


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Exchanges and Commodities 13and widespread among the publ ic . In pre-war years r ice was the s tar p layer onthe Japanese futures markets but wi th the advent of s t r ic t government cont rolon dis tr ibution of r ice, this commodity has long been absent from trading.

The act ivi t ies of exchanges typical ly involve things in addit ion to futurestrading. Firs t in importance among these is the operat ion of cash markets fort rading in spot or actual commodi t ies . The var ious grain exchanges operate cashmarkets where samples of cash grain are brought to the t rading f loor and buyersand sel lers negotiate on exchange of t i t le. Other nonfutures function includeestablishments of rules and commission rates for t rading in cash commodit ies ,weighing of commodi t ies moving through the terminal and, inspect ion andes tabl ishment of grades . At some exchanges , as Minneapol is Grain Exchange,the nonfutures t rading roles are dominant whi le o thers are concerned a lmostexclusively w ith futures tr ad ing . O ur concern here is w ith futures m arke topera t ions .The var ious exchanges are separate and independent organizat ions , each wi thi ts own his tory, t radit ion, and identi ty. This separateness is jealously guarded;each is vain ab ou t its ope rat ion and im porta nce and the re are instances ofr ivalry almost to the point of confl ict . This is t rue even though there are peoplewho are members of more than one exchange and there are many companieswho have members of al l of the U.S. exchanges in their employ. That is , thelarger commiss ion houses must have employees who have t rading pr iv i leges onall exchanges if they are to adequately serve their customers. Commodity exchanges have common problems wi th regard to ru les , regulat ion, and procedures as wel l as re la t ionships wi th the federal government; they have commoncause and there is basis for close cooperat ion and not great basis for intensivecompeti t ion because the different exchanges general ly trade in different commodi t ies . Yet cooperat ion i s only s lowly evolving. This independence s temsfrom personal i ty t ra i t s of people who t rade commodi t ies and are members ofcommodi ty exchanges . As a general mat ter they are independent , compet i t ive ,and egotis t ical . There is a defini te pecking order among the exchanges. Theproblem is that membership of each exchange th inks i t s exchange i s a t the headof the l ine.

In spite of the independence of the exchanges their organizat ion and operat ion is m ore not ab le for s imilar i ties than differences. The ir rules and proc edure svary in detai l , but not in essentials . I t is thus possible to present a composite ofexchange o rgan iza t ion and opera t ion .

Objectives. The pr imary a im of a commodi ty exchange i s to provide andregulate a market p lace so that i t s members , and through them t rade in teres ts ,including the public, have facilities for trading in futures contracts for specificcommodit ies . The object ives are: (1) To establish equitable principles of business condu ct by me m bers , (2 ) T o provide an organized m arket p lace and es tabl i sh the t ime of t rading, (3) To provide uni form rules and s tandards for the


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14 Descriptionconduct of trading, (4) To establish uniformity of contract size and tradecustoms regarding quality and its establishment, time and place of delivery, andterms of payment, (5) To collect and disseminate price and market informationto members and the public, (6) To provide a mechanism for the adjustment ofdisputes among members, and (7) To provide machinery to guarantee thesettlement of contracts and the payment of financial obligations in connectionwith trading among members. In addition there is an unstated but neverthelessgenerally recognized objective and obligation to guarantee the financial andbusiness conduct integrity of members in their commodity contract dealingswith nonmembers. In short, the exchanges provide the playing field and equipment, write the rules, and act as referee, head linesman, and field judge but donot handle the football. They do not trade and neither win nor lose although, asfootball officials, sometimes get written up (or down) in the newspapers.

Governance. Commodity exchanges are great democratic bodies, governedand operated by the members. Governm ent is vested in a Board called Board ofDirectors, Board of Governors, or Board of Managers. The Board is elected bythe membership and its officers are either elected by the members of the Boardor the membership. Directors, governors, or managers typically serve threeyear terms with annual elections so that there is continuity of Board composition.The number of Board members is large, typically 15 to 21. Some exchangeshave two or three non-member or public directors appointed by the Board.Boards are selected in the best democratic tradition so that they are representative of the various facets of the membership. Some exchange by-laws require adiversity of occupations as merchants, processors, commission houses, and independent traders, or a minimum of directors from outside of the city where theexchange is located. But the balance of the Board is usually taken care of by theelection process. Officers and directors are typically slated by a nom ina ting committee. Sometimes the slate is not opposed, but more often it is. The processresults in a balanced representation of interest groups. There is no formalorganization of interest groups that would parallel a precinct or ward structure,but there are informal cliques so that Board members are often representative ofa constituency.A high proportion of the work of the Board is done by committees that areappointed by the Board from its own members and the exchange membershipat large and elected, in some cases, by the exchange membership. The numberof committees is large. In 1974, there were 27 committees of the Chicago Boardof Trade, 30 of the Chicago Mercantile Exchange, 26 of the Kansas City Boardof Trade and 19 of the New York Cocoa Exchange.

Names of committees and specific duties vary by exchange. Typically, thereare committees that deal with matters pertaining to: ( l ) Floor Trading Practices, (2 ) Price Rep orting, (3) Business Conduct, (4) Arbitration , (5 )


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Exchanges and Commodities 15Appeals, (6) Nomination, (7) Membership, (8) Amendments to the Rules,(9) Commodities [several] (10) New Commodities, (11) Weighing, Warehousing, and Delivery, (12) Physical Facilities Management, (13) Supervisionof Finances and Properties, and (14) Public Relations and Education.

Day to day administration of each exchange is accomplished by executiveofficers and staff. They are responsible for carrying out the policies and decisionsof the Board and the various committees. Departmental organization of thestaff typically parallels the committee structure. The size of the staff varies withthe size of the exchange and is more or less proportionate to the volume of business done on the exchange. In 1974, there were 210 on the staff of the ChicagoBoard of Trade, 90 on that of the Chicago Mercantile Exchange, and 20 on theKansas City Board of Trade.The development of the staff function is fairly recent. It was not until 1948that the Chicago Board of Trade had its first paid executive officer. By-laws ofexchanges are quite detailed and involve specific limitations on the powersdelegated to the Boards. Seemingly minor matters must go to the vote of themembership. Members of the Boards take their responsibilities quite seriouslyand delega te limited responsibility to the staff and closely review the work of thecommittees.A high proportion of the committee members take their jobs seriously, attendcommittee meetings frequently and regularly, and remain on committes for extended periods. They work closely with the paid staff whose jobs are in thearea of the responsibilities of the committee.Financing. The North American exchanges are nonprofit organizations. Theyprovide the facilities through which members may attempt to operate for profitbut their objectives do not include making money. As a general proposition, oneof their objectives necessarily includes staying solvent and paying the help.Almost without exception they lack the funds to do the things that their paidstaffs and many members would like them to do.The exchanges are financed in three principal ways: investments, dues, andfees. Some exchanges own the buildings in which they are housed and rentspace and some have substantial investments in other businesses and securities.Members of most exchanges pay annual dues that are levied to cover operatingdeficits. These dues are not very large but even so members tend to resist increases. The assessment of the Chicago Board of Trade, the largest of themarkets, was $600 per member in 1975. Income from fees include forwardingprice quotations and price quotation equipment, weighing and inspection ofcommodities, rental of communication equipment, tables and booths on the exchange floor, and the sale of literature prepared by the exchange. Some exchanges charge a transaction fee instead of levying dues so that the cost ofexchange operation is paid in direct proportion to the use made of the exchange.Membership. The membership in U.S. exchanges is limited to individuals


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16 Descriptionthere are no memberships held by companies. Only members of exchanges areallowed to trade in future contracts. The typical commodity exchange has afixed, limited number of memberships but some, for examp le the W inn ipe gCommodity Exchange, have no limitation on the number of people who may beadmitted to memberships. The U.S. exchanges, where futures trading is active,have limited m embership.The number of exchange members is sometimes fixed by the charter andsometimes may be adjusted by the board of directors. The number of membersat the various exchanges varies over time. There were 82 original members ofthe Chicago Board of Trade. In the 1920's the number exceeded 3000 beforefalling off sharply in the 1930's. A limit was fixed at 1422 where it remaineduntil 20 memberships were retired in the 1950's and a new limit established.Memberships on active exchanges are generally of value and have a price, theprice varying with the activity of the exchange. In addition to trading privileges,there are often property values involved. The Chicago Board of Trade, forexample, owns the large office building in which it is housed. During much ofthe post-World War II period the real property value per member was worthmore than the going market price of memberships. The value of membershipson that exchange fell to $3,500 before the action to retire 20 memberships wastaken. The price ranged from $90,000 to $125,000 in 1975.Membership in The Chicago Mercantile Exchange was limited to 500 through1974. This was too small a number to accommodate the increasing volume oftrade as had been apparent for several years. In 1964, the memberships tradedfor as little as $3,000. With the growth of the markets values rose rapidly sothat a membership traded for $84,000 in October, 1969. The situation presentedthe exchange with an interesting problem: A general feeling that a larger membership was needed to handle the large volume of business, but also a knowledge that an increase in the number of members would reduce the value ofmemberships (or cause them to increase less than they otherwise would).Nothing was done. By 1975, the price range was $77,000 to $129,500. In late1975 they decided to make trading privileges in non-livestock commoditiesavailable at $20,000. They authorized 150 of these with the expectation thatwhen they were all taken up that another 150 would be offered. The action wasdesigned to serve two purposes. First, to increase the number of people to carrythe increased volume, and second, to stimulate trading in commodities that theExchange though t needed increased attention.The Chicago Board of Trade had a similar problem and took similar action.In 1975, when trading in mortgage futuresGNMAwas started, they authorized the sale of 100 tradin g privileges at $5,000 per year for the first year.

There are less active exchanges in which the authorized membership has notbeen fully taken up and in which members would be hard pressed to sell at anyprice.


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Exchanges and Commodities 17Memberships in the major exchanges are broadly held, both occupationallyand geographically. Membership lists include every facet of the industry in thecommodities traded: producers, warehousemen, exporters, importers, processors, merchants, brokers, futures commission merchants, and speculators. The

geographical spread of memberships is as broad as the geography of the commodity with numerous mem berships held by non-U.S. citizens.There are two reasons for owning a membership; to get on the floor andtrade, and to obtain the reduced commission rates extended to members who arenot present at the market but trade through agents. Usually, member commission rates are one half of nonmember rates. A varying proportion of themembership is on the trading floor at any given time. Typically, about 40percent of the membership is on the floor of the more active exchanges. Theproportion is less on the less active exchanges.While memberships are held by individuals many of them are effectivelycontrolled by companies. Many members are employees of firms whose businessinvolves futures trading. The companies loan the individuals money to purchasememberships, get agreements for surrender when the employee leaves the company, and sponsor the applicant.The principal requirements for membership are that the applicants be ofgood character and financially responsible. Generally, applicants are endorsedby two members. Financial requirements vary by exchanges and by the purposeof the membership. If the applicant is going to use the membership for himselfthe requirements are fairly high but if it is to be a "company membership" theapplicant's personal financial position is not a significant determinant. Applicants names are posted with an invitation to the membership to comment. Afteran applicant has passed a membership committee he is recommended to theboard of directors which may elect him. The newly elected member must subscribe to the by-laws and rules and agree to abide by all existing regulations andsubsequent amendments. He, in effect, submits to the law of the exchange withregard to contract trading.

Once elected the applicant may negotiate a purchase from a member (inN . Y . exchanges, a seat is usually bought first in the name of a member). Hebids until he persuades a member to sell or becomes discouraged by competitivebids and asking prices. He has a limited time for negotiation; if he does notmake a purchase within the time limit his election is voided.Obtaining a membership is not all that complicated or difficult. The exchanges are relatively open; a bit more net worth than the price of the membership and the absence of a bad reputation appears to be all that is required.Settlement of disputes. Disputes in trading occur on all exchanges. Theyinvolve identity of trades, prices, quantities, and trading rules and have acommon elementmoney, large sums and small. Exchange rules provide forarbitration without recourse to courts of law. Some exchange rules require that


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18 Descriptiondisputants submit to arbitration on the complaint of one party while otherssimply provide machinery for voluntary arbitration when requested. As a practical matter, disputes that cannot be reconciled between the individuals concerned go to the arbitration committees.

The arbitration procedure is comparable to an action at law but is stripped oflegal formalities, rigidity, and is private except as the disputants request opensessions. The arbitration committees have extensive powers, including the production of papers and subpoena of members to attend and give testimony. Thefindings of the arbitration comm ittee may be taken to a board of ap peals bu t theawards of this group are final and conclusive and have the full force of law.Once the arbitration proceedings have been agreed on, either voluntarily or bythe terms of membership, the courts refuse to intervene until the arbitrationprocess has been exhausted. Appeal can then be made to the courts only on themost narrow grounds of violation of constitutional rights or of the charter andby-laws of the exchange. In short, the exchanges settle disputes and disciplinetheir members. There have been legal actions regarding monetary awards anddisciplinary actions, including expulsion, but these are rare and nearly alwaysunsuccessful.Commodities Traded

The list of commodities actively traded in North American futures markets isimpressive for its length and diversity. Some classification is possible andperhaps even useful. The list is:G rains: W hea t, corn, oats, barley, grain sorghumsOilseeds and Products: soybeans, rapeseed, flaxseed, soybean meal, soybeanoil, coconut oil, palm oilLivestock and Products: Cattle, feeder cattle, hogs, broilers, turkeys, pork-bellies, skinned hams, boneless beef, eggsFoods: Potato es, orange juice, sugar, coffee, cocoaFibers: Cotton, woolForest Products: Plywood, lumberM etals: G old, silver, platinum, p alladium , copper, U .S. silver coinsPetroleum: Propane, crude oil, industrial fuel oil, heating oilCurrencies and financial instruments: British Pound, Canadian Dollar,Deutschemark, Japanese Yen, Mexican Peso, Swiss Franc, French Franc,Dutch Guilder, Federal guaranteed Mortgages (GNMA), U.S. Treasurybills.There is a tendency toward specialization in groups of commodities by thevarious exchanges. The Kansas City and Minneapolis markets trade in only


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Exchanges and Commodities 19grains and most of the trading on The Chicago Board of Trade is in grains,soybeans, and soybean products. The Chicago Mercantile Exchange is primarilya livestock and livestock product market, while the Commodity Exchange, Inc.is primarily a futures market in the metals. On the New York Cocoa Exchange,trading is in cocoa futures exclusively. But specialization is not complete. Silver,gold, broilers, cattle, and plywood futures are traded on the Chicago Board ofTrade, and the New York Mercantile Exchange trades in the interesting combination of palladiu m, platinum , plywood, potatoes, industrial fuel oil, heating oil,boneless beef, silver coins, gold, and eight foreign currencies. Some commodities are traded on more than one exchange: wheat at Chicago, Minneapolis, andKansas City, silver on the Chicago Board of Trade, the MidAmerica Commodity Exchange and the Commodity Exchange, Inc., and potatoes on the NewYork Mercantile and the Chicago Mercantile.

The list of the commodities above was one point in time, late 1975. Themakeup was different in earlier times and will doubtless be different in thefuture. In the 19th century there was a futures market in petroleum at Oil City,Pa. Lard futures trading was formerly of major importance on the ChicagoBoard of Trade but was last traded in 1963- Cottonseed oil was actively tradedon the New York Produce Exchange. Commodities previously traded but notnow active on the Chicago Mercantile Exchange include: onions, scrap iron,frozen shrimp, frozen broilers, butter, hides, and apples.Th e list becomes more interesting as the blanks are filled in. Other imp ortantoilseeds in world commerce include sunflowerseed, peanuts, and cottonseed.Other edible fats and oils include lard, cottonseed oil, butter, and fish oil.Orange juice makes the list but not pears, peaches, and grapefruit juice. Inaddition to the above, livestock by-product feeds include wheat millfeeds, corngluten feed, linseed meal, meatscraps, etc. Interesting and surprising commodities are in the list but the list is by no means com plete.As we shall see, the volume of trading varies greatly within commodities atdifferent times and among commodities. A couple of examples are sufficient at

this point: 1) There were 60,000 contracts of oats futures traded on the ChicagoBoard of Trade in 1967 and 123,259 contracts in 1968, more than double, whilethe contracts of rye traded decreased from 45,770 to 28,143 between the sametwo years. The total value of all commodity contracts traded on the ChicagoBoard of Trade was estimated at $50.1 billion in 1967 but only $35.0 billion in1968. 2) In 1968 there were 1,398,200 contracts of pork bellies traded on theChicago Mercantile Exchange but only 204 contracts of hams. Now, each bellyis attached to a ham and each hog has two of each. A ham is wo rth a little morethan a belly, and the prices of hams vary quite as much as bellies. An anomaly;very interesting.Common Characteristics. Why are some commodities traded on futures markets while others of similar characteristics and equal importance are not ? W h at


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20 Descriptioncommon characteristics do commodities traded have ? The answer to the first ofthese questions is quite involved and must await further development of oursubject. Some characteristics of commodities prerequisite to their being tradedin futures markets have been enumerated. The Federal Trade Commission2listed ( l ) homogeneity such that commercial units are interchangeable, (2 )durability, or minimum degree of perishability, and (3) an adequate supply ofthe actual commodity flowing to or through the terminal market where thefutures market is established. They added that a large volume of trade isobviously not a prerequisite, but is essential to the highest efficiency of a futuresmarket.Baer and Saxon3 developed a rather exacting list:1. Units must be homogeneous. It is a condition precedent for all futurestrading th at units of the commodity be interchangeable. T he trader does not buyor sell a contract for a specific or identified grade or specific lot but buys or sellsaccording to established grades and descriptions. The commodity need not betangible but must be describable.2. The commodity must be susceptible of standardization and grades. Differences make it impossible for every unit of a commodity to be regarded commercially as the equivalent of every other. If standards can be established so that byinspection and classification the commodity may be divided into a definitenumber of well defined, uniform grades the units of each grade become homogeneous, the commodity is suitable for futures trading.3. Supply and demand must be large. The authors use alligator pears as anexample of a commodity for which a satisfactory futures market could not bemaintained. Both the supply and demand are small, consequently speculatorswith large financial resources might gain control so that it would cease to be anatural and free market and become merely a battleground for contendingspeculative factions.4. The supply must flow naturally to market. Not only must a supply of acommodity be large, but its flow to world markets must also be substantiallyfree and unhampered by artificial restraint, whether by government or privateagencies. They cite several examples of commodities whose supply has been substantially affected by individual governmental actions and marketing agreements.

5. Supply and demand must be uncertain. If supply and demand are bothcertain, prices are capable of ready adjustment without the intervention of anyorganized market machinery. When supply and demand are large, and bothuncertain and subject to wide fluctuations from season to season or year to year,a condition exists where the forces of supply and demand on free markets is2 Ibid . , pp. 24-25.3 Baer, Julius B. and Saxon, Olin Glenn , Comm odity Exchanges and Futures Trad ing Ha rper &Brothers, 1948. Chap. VI.


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Exchanges and Commodities 21cons tant ly changing. This in terplay of uncer ta in economic forces produces theconstant f luctuations in price which must exis t in any successful futures market .

6 . The commodi ty should not be too per ishable because the futures cont ractmay cal l for a del ivery of units of the commodity many months into the future.Consequently, the commodity must be capable of being s tored at al l t imes andfor considerable periods to meet requirements of the market in t imes of scarci ty.A commodi ty subject to rapid deter iorat ion does not meet th is requi rement .

The same authors d iscussed commodi t ies not adaptable to fu tures t rading.H ere they l i s t: (1 ) per ishable comm odi t ies as unca nned f ruit s and vegetables ,(2) manufactured goods whose supply can be control led and whose s ty leschange, and goods where the supply i s under monopoly control , c i t ing sulphurwi th the supply control led by two major produ cers .

In looking over the l is t of commodit ies t raded, i t is clear that the l is ts ofrequirements do not explain why some commodi t ies are t raded and others arenot nor why the volume of trading ranges so great ly by commodit ies and overt ime. Some common character is t ics can be identif ied. Firs t , they are al l bulkcommodit ies that can be described and the separate lots of which are more orless interchangeable. Second, none of the commodit ies has been processed ormanufactured to the point of being a product identif ied with the processes of apart icular f irm; in general they are bulk commodit ies but are not , in a s tr ictsense, raw materials . Third, pr ices are variable and relat ively competi t ivelyde te rmined .There are character is t ics that are not common to al l of the commodit ies . Mostnotable is the high degree of perishabil i ty of some. Catt le, hogs, iced broilers ,and fresh eggs are the most notable examples. For some of the commodit ies , forexample corn, there are many suppliers and many users so that there is noimportant control of ei ther the supply or use s ide by a few firms; the conditionof atomist ic competi t ion is fair ly met. But for others , there is a relat ively highdegree of concentrat ion as in the case of broilers and soybean oil where a fewfirms control a high proport ion of the supply. Some of the commodit ies f lowthrough a market ing sys tem of country points , subterminals , and terminalmarkets to and through a dis tr ibution system. But for others the f low of actualproduct is highly decentral ized as in the case of fats and oils , potatoes, andlivestock. A central ized market is not a prerequisi te to futures trading. Severalof the commodit ies , grains in part icular , have supply, demand, and price s tructures that are affected by various kinds of go vern m enta l p rog ram s.

The inst i tut ion of futures trading has broadened the defini t ion of the termcommodity. The introduction of t rading in various foreign currencies in 1972added a different dimension as did the later addit ion of federal ly guaranteedm ortg ag es and U.S. t reasury bi l ls. Th ese and oth er f inancial in strum ents arebulk, inte rcha nge able , and have f luctuating value s. T h e possibi li ty of t ra din gin ocean f re ight has been explored. These developments ra ise an in teres t ing


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22 Descriptionquestion about the possible ultimate scope of futures trading. It appears unlikely, but certainly is conceptually possible that labor contracts might one daybe included.From these considerations it appears to be a mistake to impose a very rigorousset of prerequisite characteristics for eligibility for futures trading. It seems thatif a commodity is describable, interchangeable with other similarly describedlots, and has a variable price, it may be traded on an organized futures market.Perhaps the appropriate question is not why some commodities are traded butrather why so many others are not.The Dynamics

Futures trading is an unstable activity. The quantities traded vary sharplybetween days, months, and years. Trading in individual commodities is startedand fades out or plods along, going nowhere, or takes hold and grows rapidly.Exchanges come and go. W e w ill explore some of the reasons for the dynamicsin later chapters, but at this point some description is useful.Table 1 is an attempt to take a very long run look at the volume of grainstraded. There are no usable records prior to 1884. Trading on all markets wascombined in developing the table. The first point of particular interest is thatthe all time peak of trading in grain probably occurred in the 1880's. Thegeneral level of activity held fairly constant through the 1920's. The greatdepression of the 1930's, the introduction of various farm price support andinventory schemes, and fixed prices of World War II pulled the volume downto about one third of the earlier level. Vo lume improved by the mid-1960's, andincreased rapidly from 1966 through 1974.The table does not include cotton because of the lack of continuous data butthe general pattern appears to have been similar. It does not include soybeansbecause of the relative recent origin of the crop. There was futures trading inother commodities, particularly from 1920 on.

Table 2 shows the detail of trading volume by exchanges and commoditiesfrom 1961 through 1975. Volume is but one measure of the size and importanceof trading. It is the most commonly used and most readily available measure.There are several points of interest.1. Total volume of trading was fairly stable through 1965; there was a rapidincrease from 1966 through 1972, and a veritable explosion beginning in mid-1972.2. Some exchanges declined in importance and disappeared from the list andothers were fading throughout most of the period. Milwaukee declined anddisappeared just as the New Orleans Cotton Exchange, the Memphis Board ofTrade, and the Seattle Grain Exchange had in the 1950's. St. Louis came in andleft p romp tly. Th is is a very old market th at had a large volume of tradin g at an


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Exchanges and Commodities 23Table 1. Volume of Futures Trading in cereal grains,wheat, corn, oats, barley, rye on U.S. Markets, five

year averages, millions of bushels.1884-881 8 8 9 - 9 31 8 9 4 - 9 81899-031 9 0 4 - 0 81909-131914-181921-251926-301 9 3 1 - 3 51 9 3 6 - 4 01941-451 9 4 6 - 5 01951-551 9 5 6 - 6 01961-651 9 6 6 - 7 01 9 7 1 - 7 4

23,60018,00021,60019,40018,90016,00019,40021,75320,33613,48910,4916,481

9,6408,8987,764

10,43017,18025,803

Source: Federal Trade Commission and Commodity Exchange Authority, U.S.D.A.

earlier time and remained an important cash grain market at the end of theperiod. The New York Produce Exchange, after a rally in the early 1960'sdeclined and disappeared.3. The number of commodities traded increased. There were 30 differentcommodities traded in 1961 and 50 in 1975. There was a tendency to add commodities rapidly near the end of the period. Note particularly, increases in themetals and financial instruments and the development of specialized contracts

for the same commodity on the various exchanges.4. Trading in some commodities declined and stopped or nearly stopped(Frozen shrimp, millfeeds, cottonseed oil, wool tops, tomato paste). Volume inothers declined gradually and then recovered sharply, such as eggs on theChicago Mercantile Exchange. Some commodities were introduced and becameinstantly successful, while others were introduced and flopped. The most striking contrast is pork bellies and skinned hams. Belly trading was started in 1961and ham trading in 1964. Belly trading was quite successful by 1965, but hamtrading had not developed. The two have quite comparable characteristics, buttraders in futures contracts responded very differently.Figure 1 shows graphically the explosive growth in futures trading since1961.


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Exchanges and Commodities 29Table 3 shows the share of to ta l volume on each of the exchanges . The com

parisons are less than perfect ly accurate because of differences in commodityvalue per uni t ( soybeans are wo r th ap proxim ately 2 .5 t imes as much as corn,but the contracts are 5,000 bushels for both commodit ies) and differences incontract s ize . (Grain contracts on the MidAmerica Commodi ty Exchange a re1,000 bushels each, but are 5,000 bushels on other exchanges. In 1974, the426,686 wheat cont racts t raded on the Kansas Ci ty Board of Trade represented 2 .1 bi l l ion bushels , whi le the 623,939 wheat cont racts t raded on Mid-Amer ica represented only 624 mi l l ion.)

The Chicago Board of Trade i s the larges t exchange, but i t s pos i t ion ofdominance decreased rapidly in the 1960's before leveling off in the first half ofthe 1970 's . The rapid growth of the Chicago Mercant i le Exchange i s associa tedw ith the intro du ction of Po rk Belly tradin g in 196 1, Live Catt le in 1964, andLive Hogs in 1966. All three markets have been very successful . The rapidgrowth of the Commodity Exchange, Inc. is associated with s i lver futurest rading which s tar ted in 1963, but which was of small consequence unti l 1968.

The most rapidly growing exchange i s MidAmerica , where volume increasedfrom 57 tho usa nd contracts in 1970 to 2.6 mil l ion in 1974. T he key to thisgrowth was the small contracts of 1,000 bushels of wheat , corn, oats , and soybeans and 1,000 ounces of s i lver . Formerly the Chicago Board of Trade permit ted trading in 1,000 bushel lots , but when this pract ice was s topped smalluni t t raders went to MidAmerica . The smal ler cont racts are bet ter sui ted to thepurposes of many grain producers and the di rect par t ic ipat ion of grain producers in futures markets has increased. The tremendous increase in pricevolat i l i ty of commodi t ies beginning in mid-1972 made the smaller contracts abetter vehicle for many people.

A point that should be especial ly noted is that in 1974, seventy percent of al lfutures trading was in the grains , soybeans and products , cat t le, hogs, and pork

Table 3 . Proport ion of Total Trading on Each Exchange

ExchangeC h i c a g o B o a r d o f T r a d eC h i c a g o M e r c a n t i l e E x c h a n g e a n d

I n t e r n a t i o n a l M o n e t a r y M a r k e tK a n s a s C i t y B o a r d of T r a d eM i d A m e r i c a C o m m o d i t y E x c h an g eM i n n e a p o l i s G r a i n E x c h a n g eN e w Y o r k C o f f e e a n d S u g a r E x c h a n g eN e w Y o r k C o t t o n E x c h a n g e a n d

A s s o c i a t e sN e w Y o r k M e r c a n t i l e E x c h a n g eN e w Y o r k C o c o a E x c h a n g eC o m m o d i t y E x c h a n g e , I n c .P ac if ic C o m m o d i t i e s E x c h a n g e

T o t a lT o t a l c o n t r a c t s ( 0 0 0 ' s )

19627 6 . 0 1

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19754 9 . 5 11 9 . 8 8

1.897 .50.6 2

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30 Descriptionbellies. In spite of the proliferation of commodities traded that has taken placesince I960, the bulk of futures trading is in primary agricultural comm odities. Itmay be that this market form will become of major importance for an evenlarger list of commodities than now listed, but only time will tell.

The major changes of exchanges disappearing and commodities coming andgoing tend to obscure the large changes that take place in the more stable areas.The area of greatest stability appears to be grain, soybean, and soybean producttrading on the Chicago Board of Trade. But it is also unstable. In the 15 years(1961-75) the volume of trading in wheat ranged from 517 thousand contracts(2.6 billion bushels) to 2.4 million contracts (12.0 billion bushels). The othershad comparable ranges.What all of this does is raise the question of why some commodities aretraded and others not and why the volume varies as it does. Obviously, theexchanges don't know for sure, else there would not be such a record of failures.


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economics of futures trading for commercial and personal profit chapter2

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