Wheat futures contracts prevent prices from wavering like stalks in the wind.
A wheat futures contract specifies an agreed price for a designated amount and quality of wheat to be delivered at a future date. It is used to lock in current prices notwithstanding price changes prior to delivery date. Grain producers and consumers use wheat futures to hedge price risk; speculators use them to bet on future prices of wheat. If wheat prices increase over the contract term, the buyer can sell the contract for a profit. A price decrease is a loss to a contract buyer. Wheat futures contracts are standardized and traded at commodity exchanges throughout the world.
Instructions
1. Identify the characteristics of the wheat specified in the futures contract. To properly evaluate the wheat to be delivered, identify the type and quality of wheat and the number of bushels per contract. For example, a typical wheat futures contract at the Kansas City Board of Trade (KCBT) specifies 5,000 bushels of hard red winter wheat of No.1 quality. Separate contracts are offered for different wheat qualities.
2. Identify the price-related characteristics of the futures contract. Wheat is priced in cents per bushel. Commodity exchanges establish the minimum price fluctuation -- known as the tick value -- as well as daily price-change limits. The Chicago Board of Trade (CBOT) wheat futures tick value is ¼ cent per bushel, equivalent to $12.50 per contract. The CBOT daily price-change limit starts at $0.60 per bushel for later delivery months; price changes for the current month contracts are unlimited on or after the second business day preceding the first day of the delivery month.
3. Study a commodity exchange's trading practices for wheat futures. The KCBT trades wheat futures, either electronically or through open outcry, for five different delivery months: March, May, July, September and December. A KCBT futures contract's last trading date falls on the business day preceding the 15th of one of these delivery months, and the last trade must be executed by 1:15 p.m. KCBT wheat must be delivered no later than the second business day following the last trading day of the delivery month.
4. Calculate the cash flows associated with a wheat future. Contract buyers and sellers must post and maintain collateral on their positions. Exchanges mark-to-market contract prices daily and transfer cash collateral between buyer and seller depending upon which one benefited from the day's price action. Since wheat futures require physical delivery, the counterparties must also consider load-out and storage fees. At final settlement, the buyer must pay the contractual amount in return for delivery of the wheat.
