Trailing Stop Order – What Is It and How Does It Work?
Trading guides, webinars and stories
Trading guides, webinars and stories
One of the stories savvy brokers use for effect, is the tale of a beginner Futures trader who accidentally left a position open and woke up to see several trucks worth of wheat delivered to their doorstep.
The story’s perfect for peaking people’s interest as an introduction to Futures trading, however, we can almost certainly claim that it’s not something that has actually happened or at least not in the way described above. Even so it’s worth asking how these contracts are actually fulfilled in practice and whether traders have any reason to fear something along these lines happening to them.
Presumably something like this had a much higher chance of occurring during the initial emergence of the Futures market. At the time it was mostly used by those with a stake in the price of the respective asset to hedge their risk. It’s development was shaped by agricultural producers, farmers, grain merchants and processing companies. Margin based investing soon caught the attention of speculators as well, who eventually took control of the prices. Today these same profit oriented speculators make up 95% of the market’s trade volume. Cases where one of the parties actually owns wheat, oil or any other commodity have become almost an exception.
One has to wonder how deals on physical assets are made under these conditions as well as how said assets are actually delivered. To get to the bottom of it, it’s important to take a closer look at the published details of these contracts in addition to the rules of the particular brokerages that provide them. In reality most brokers fundamentally reject any involvement in the actual physical delivery of the contracts’ respective asset. Positions are automatically closed and settled in cash at the moment of expiry, meaning there’s zero risk of a carrier with a shipment of wheat knocking on your front door.
If the broker is open to offering physical delivery, then it becomes necessary to get an additional institution involved. The clearing house serves an imperative role in this process, it keeps track of changes in the ownership of contracts. It also keeps track of the various warehouses and depots that can potentially serve as both the origin and destination of physical deliveries. It’s also worthwhile to point out that physical deliveries are only possible for front month contracts, although traders can purchase contracts with expiries of up to a year and a half.
The above image illustrates the specifics of a contract on corn Futures found on the CME’s website. The first date shows from when the contract can be purchased. In this example it was already on the market in December of 2016, however, it’s expiry was March 2019. The Settlement date coincides with the Last Trade day. That’s the moment when the closing price is determined, which was also the settlement price of physical delivery.
First Holding marks the beginning of when position dates are accepted. This period lasts until the day after the contract’s expiry. The First Position date indicates the start of the time frame for when the Clearing House accepts intents for deliverable contracts, lasting just as long as the First Holding Period. The day after users get notified that they’ve been assigned a delivery, when the Clearing House coordinates the place of delivery and the quality of the commodity stock with the warehouses. Once all of that is settled the first delivery begins and it needs to be completed by the fourth day after the contract’s expiry at the latest.
This lengthy process should give one an idea of how many steps a trader needs to take to finally receive their order. It’s also important to note that in the majority of cases delivery happens not by any means of transportation, but rather by handing over the warehouse receipt. These receipts are negotiable securities issued by the warehouse that act as proof of ownership of stored commodity.
Going back to our original example, it’s not enough forget to close a position, but rather one needs to proactively make a series of mistakes before any kind of actual physical delivery can take place. Even then, it would most likely end in either receiving a paper trail in the mail or a digital document confirming the transaction. Reality is unfortunately nowhere near as exciting.