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| this is good explanation by other site...agriculture.com
which by the way..I have no luck registering over there, ja. Anyone else have difficulty? LOL
Re: How does CBOT work?
"Out of all the open interest in the futures markets only a fraction ever is held to delivery… I would guess less than 1%....but the contracts are used as a hedge and basis is derived from the difference between futures and cash. So that the “threat” of delivery forces futures markets to converge with the cash market. If the futures markets are fair to cash then there is no incentive to make or take delivery of the contracts. If there is stubborn open interest that stays too long when there is no incentive then the market will tend to punish the holder into delivery because there interest creates the opportunity for the merchandiser to delivery grain at a profit. Conversely if futures prices are too cheap to the prevailing cash bid then there is an opportunity to “take” for “stop” the futures contract and receive the cash grain there-fore punishing the shorts who have stayed to long… in these instances the market enforces convergence and with most opportunities arbitraged out of the delivery trade and so very few contracts go to delivery….the process however makes the futures(derivative contracts) perform as a viable hedge to the underlying cash transaction.. Most public held companies that use derivatives must prove an 85% correlation or they risk the auditors wrath of being speculative… the delivery process has done a good job in forcing convergence narrower than this benchmark.
Another often pointed out topic is the notion that open interest in wheat or corn can often time exceed the physical crop by 3 or 4 times… This happens because the crop changes hands numerous times from the farm to the merchant, to the processor, to the end user, the exporter, the importer… and each of these points of transaction can have and often do hedge themselves at varying times throughout the marketing year… so their interest represents the same crop but the “velocity” of the crop is many times the actual crop size… and this turn-over is reflected in open interest larger than the actual crop. Also much of the foreign production is being cross hedged with our markets particularly the wheat contract. Also traders at other exchanges in other countries arbitrage price relationships between crops. Such as Australian or French/FSU wheat with US SRW…"
Hope this helps,
Mike
http://community.agriculture.com/t5/Marketing/How-does-CBOT-work/m-...
Edited by Gottlieb 7/25/2013 12:45
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inner workings CBOT
