852 Futures Markets

The introduction of financial futures — futures on currencies and interest rates — during the 1970s transformed the futures markets, which had been trading agricultural commodities for more than 100 years. Financial futures brought new participants and new strategies to the futures markets, and many more types of risk could now be hedged. The commodity concept has broadened to include energy, beginning with heating oil futures in 1978; many of the strategies that were devised for financial futures have been adapted and applied to the energy markets. Energy futures contracts are used by producers, refiners, and consumers to hedge against price fluctuations in these volatile markets. Another function of energy futures contracts has been to protect the inventory value of crude oil, refined products, and natural gas.

The oil futures market developed to allow oil traders to offset some of their risk by taking a position on the futures market opposite their physical position. A producer, who has the physical commodity to sell, hedges by selling futures. The producer's position is then long cash and short futures. A consumer, who needs to buy the commodity, hedges by buying futures. The consumer's position is then short cash and long futures.

A futures contract is an agreement between two parties, a buyer and seller, for delivery of a particular quality and quantity of a commodity at a specified time, place, and price. Futures can be used as a proxy for a transaction in the physical cash market before the actual transaction takes place. The commodity exchanges set margin requirements for hedgers and speculators. The buyer or seller of a futures contract is required to deposit with the clearinghouse a percentage of the value of the contract as a guarantee of contract fulfillment. The margin deposit made when the position is established is called the original margin. Hedge margins generally are lower than speculative margins. At the end of each trading day, each position is marked-to-market, i.e., the margin requirement for each account is adjusted based on the day's price changes. If the value of the position has decreased, the holder of the contract will have to make an additional deposit, called the variation margin. This fulfilling of margin requirements on a daily basis means that the extent of default in the futures market is limited to one day's price change.

Although futures contracts require physical delivery, most do not go to physical delivery because they are settled financially. Therefore, futures should generally be used as a price risk management tool, not as a source of physical supply. This basic concept is still a stumbling block to futures trading, as many potential futures players think that physical delivery is a key component of futures trading, when, in fact, the vast majority of futures deals are settled financially.

The three major energy futures exchanges are the NYMEX, IPE, and SIMEX (Singapore International Monetary Exchange). For electricity and natural gas, only the NYMEX and IPE will be significant. Besides launching two electricity futures contracts on March 29, 1996, the NYMEX launched electricity options one month later on April 26, 1996. An option gives the holder the right, but not the obligation, to buy or sell an underlying instrument, in this case a futures contract, at a specific price within a specified time period. Options can be used to establish floor and ceiling price protection for commodities and offer a risk management alternative to futures contracts.

There are two types of options: puts and calls. A put is an option to sell the futures at a fixed price. A call is an option to buy the futures at a fixed price. For hedgers, a put establishes a minimum selling price but does not eliminate the opportunity to receive higher market prices. A call establishes a maximum buying price but does not eliminate the opportunity to buy at lower market prices. Options contracts can be used in combination with futures to form hedging strategies for exchange-traded commodities. They will be widely used in electricity price risk management.

The NYMEX natural gas futures contract, launched on April 3, 1990, has rapidly established itself as an effective instrument for natural gas price discovery in North America. NYMEX launched natural gas options in October 1992, adding another tool to manage risk in that volatile market. Natural gas options have enhanced liquidity in, and can buffer against, price volatility in the rapidly changing North American gas market. A second natural gas futures contract was launched on August 1, 1995 by the Kansas City Board of Trade, which is oriented to the western U.S. market. Two more NYMEX natural gas contracts were launched during 1996: one for the Permian Basin on May 31, 1996, and one for Canada's Alberta market later in the year. These multiple natural gas contracts represent the regional nature of North American natural gas markets, which will also be the case for electricity futures.

Solar Stirling Engine Basics Explained

Solar Stirling Engine Basics Explained

The solar Stirling engine is progressively becoming a viable alternative to solar panels for its higher efficiency. Stirling engines might be the best way to harvest the power provided by the sun. This is an easy-to-understand explanation of how Stirling engines work, the different types, and why they are more efficient than steam engines.

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