National Commodities Futures Exam

Futures margin is fundamentally different from securities margin. In securities, margin is a down payment (loan) to purchase stocks. In futures, margin is a performance bond (good faith deposit) ensuring both buyer and seller can fulfill their contract obligations. No loan is involved because no asset is being purchased at the time the contract is opened.

Initial margin is the deposit required to open a position. Maintenance margin is the minimum equity that must be maintained. Futures accounts are marked to market daily -- gains are credited and losses are debited each day. If the account falls below the maintenance margin level, the trader receives a margin call and must restore the account to the initial margin level (not just the maintenance level). This daily settlement process ensures the clearinghouse's financial integrity.

A long hedge (buying futures) protects against rising prices. For example, a cereal manufacturer who needs to buy wheat in six months can lock in today's price by buying wheat futures. If wheat prices rise, the gain on the futures position offsets the higher cost of purchasing physical wheat.

A short hedge (selling futures) protects against falling prices. A farmer expecting to harvest corn in three months can sell corn futures to lock in a selling price. If corn prices fall, the gain on the short futures position offsets the lower price received for the physical corn. The basis (cash price minus futures price) introduces residual risk because cash and futures prices do not always move in perfect lockstep. Understanding basis risk is critical for effective hedging.

Options on futures give the holder the right to buy (call) or sell (put) a specific futures contract at a specified strike price. When exercised, the option converts into a futures position rather than delivery of a physical asset or stock. The call buyer receives a long futures position; the call writer is assigned a short futures position.

A key difference from equity options is the underlying instrument. With equity options, the underlying is shares of stock. With options on futures, the underlying is a futures contract that itself represents an obligation to buy or sell a commodity or financial instrument. This means exercising an option on a futures contract creates additional margin obligations. Options on futures also have different expiration cycles, settlement procedures, and regulatory oversight (CFTC/NFA rather than SEC/FINRA).

The "Greeks" measure different dimensions of risk in options positions. Delta measures the rate of change in the option premium relative to changes in the underlying futures price (ranges from 0 to 1 for calls, 0 to -1 for puts). Gamma measures the rate of change in delta as the underlying price changes.

Theta measures time decay -- how much the option premium decreases each day as expiration approaches (always negative for long options). Vega measures sensitivity to changes in implied volatility. Understanding these risk measures is essential for managing options positions and constructing hedges. For example, a delta-neutral position is hedged against small price changes in the underlying futures contract.

Technical analysis studies price patterns, volume, and market data to forecast future price movements. Technicians believe that all fundamental information is already reflected in the price and that historical price patterns tend to repeat. Key tools include chart patterns (head and shoulders, double tops/bottoms), trendlines, moving averages, and momentum oscillators (RSI, MACD, stochastics).

Fundamental analysis examines underlying supply and demand factors to determine fair value. For agricultural commodities, this includes weather, crop reports, acreage, and USDA data. For financial futures, it includes economic indicators, central bank policies, and interest rate differentials. Most successful futures traders combine both approaches -- using fundamentals to determine market direction and technicals to time entry and exit points.

Spread trading involves simultaneously buying one futures contract and selling a related futures contract to profit from the change in the price difference between them. Spreads carry reduced margin requirements because the two positions partially offset each other's risk.

Common spread types include calendar spreads (same commodity, different delivery months), inter-commodity spreads (related commodities, such as corn vs wheat), and inter-market spreads (same commodity on different exchanges). Industry-specific spreads include the crack spread (crude oil vs refined products like gasoline and heating oil) and the crush spread (soybeans vs soybean meal and soybean oil). These spreads reflect processing relationships and are used by both hedgers and speculators.

The CFTC (Commodity Futures Trading Commission) is the federal government agency that regulates commodity futures and options markets in the United States. Created by the Commodity Futures Trading Commission Act of 1974, it oversees designated contract markets (exchanges), clearinghouses, and market participants. The CFTC has enforcement authority and can impose civil penalties.

The NFA (National Futures Association) is a self-regulatory organization for the futures industry, similar to how FINRA regulates the securities industry. The NFA handles registration, compliance, arbitration, and enforcement for futures industry participants. All firms and individuals conducting futures business must be NFA members. The NFA operates under CFTC oversight but is a private, industry-funded organization, not a government agency.

One of the most important customer protection rules is the requirement that futures commission merchants (FCMs) maintain segregated accounts for customer funds. Customer money must be kept separate from the firm's proprietary funds and can only be used for customer transactions. This segregation requirement is designed to protect customers in the event of an FCM's insolvency.

FCMs must compute their segregation requirements daily and report them to the CFTC. They must maintain residual interest (excess funds in segregated accounts) sufficient to cover any potential shortfalls. The Dodd-Frank Act strengthened these protections after high-profile FCM failures. Violations of segregation requirements are among the most serious regulatory offenses in the futures industry and can result in criminal prosecution.