Information Involved in Commodity Futures Contracts - dummies

Information Involved in Commodity Futures Contracts

By Amine Bouchentouf

Because commodity futures contracts can be traded on only designated and regulated exchanges, these contracts are highly standardized. Standardization simply means that these contracts are based on a uniform set of rules. For example, the CME crude oil contract is standardized because it represents a specific grade of crude (West Texas Intermediate) and a specific size (1,000 barrels).

Therefore, you can expect all CME crude contracts to represent 1,000 barrels of West Texas Intermediate crude oil. In other words, the contract you purchase won’t be for 1,000 barrels of Nigerian Bonny Light, another grade of crude oil.

Product grade

Imagine that you placed an order for a Ford Mustang and instead got a Ford Taurus. You’d be pretty upset, right? To avoid unpleasant surprises if delivery of a physical commodity actually takes place, exchanges require that all contracts represent a standard product grade.

For instance, gasoline futures traded on the CME are based on contract specifications for New York Harbor Unleaded Gasoline. This grade is a uniform grade of gasoline widely used across the East Coast, which is transported to New York Harbor from refineries in the East Coast and the Gulf of Mexico.

Thus, if delivery of a CME gasoline futures contracts takes place, you can expect to receive New York Harbor Unleaded Gas.

If your sole purpose is to speculate and you’re not intending to have gasoline or soybeans delivered, knowing the product grade isn’t as important as if you were taking physical delivery of the commodity. However, it’s always good to know what kind of product you’re actually trading.

Price quote

Most futures contracts are priced in U.S. dollars, but some contracts are priced in other currencies, such as the pound sterling or the Japanese yen. The price quote really depends on which exchange you’re buying or selling the futures contract from. Keep in mind that if you’re trading futures in a foreign currency, you’re potentially exposing yourself to currency exchange risks.

Price limits

Price limits help you determine the value of the contract. Every contract has a minimum and maximum price increment, also known as tick size. Contracts move in ticks, which is the amount by which the futures contract increases or decreases with every transaction. Most stocks, for example, move in cents.

In futures, most contracts move in larger dollar amounts, reflecting the size of the contract. In other words, one tick represents different values for different contracts.

For example, the minimum tick size of the ethanol futures contract on the CME is $29 per contract. This means every contract will move in increments of $29. On the other hand, the maximum tick size for ethanol on the CME is $4,350, meaning that if the tick size is greater than $4,350, trading will be halted. Exchanges step in when contracts are experiencing extreme volatility, to calm the markets.

The exchanges establish minimum and maximum tick sizes based on the settlement price during the previous day’s trading session. Determining the value of the tick allows you to quantify the price swings of the contract on any given trading session.