Chapter 7: Speculation

Importance in Series 3

• Crucial chapter for understanding speculation and hedging.
• Both sections often have complex problems.
• Speculation section involves calculations of profit or loss and percentage profit/loss.
• Efficient problem-solving is key due to time constraints on the test.
• Approximately 16 speculation questions on the test.

Speculation vs. Hedging

• Speculators: Buy/sell to make a profit.

  • Expect price movements to gain profit (long if expecting a rise, short if expecting a fall).
  • Add liquidity to the market, which reduces volatility.

• Hedgers: Buy/sell to reduce risk of their cash position.

  • Use futures as an offset, not to profit from futures.

Speculation Problems on the Test

• Must factor in commissions often given as round turn or half turn.
• Round Turn Commissions: Include cost of both buying and selling a contract.
• Half Turn Commissions: Include only buying or selling.
• Important to account for the number of contracts when calculating total profit/loss.

Example Problem Solving

1. Profit/Loss Calculation
   • Establish position at one price, liquidate at another.
   • Calculate profit/loss per unit, multiply by contract size.
   • Factor in commissions to get net profit/loss.
2. Rate of Return Calculation
   • Consider initial margin requirement.
   • Rate of return = Net profit/margin deposit.

Sample Speculation Problems

Example 1: Bullish on May Wheat

• Long position at $510, liquidate at $550.
• Profit of $2,000 per contract, commissions $50.
• Net profit $1,950, rate of return 78%.

Example 2: Bearish on July Corn

• Short at $6.75, buy back at $7.05.
• Loss of $1,500 per contract, commissions $25.
• Total loss $4,575 for three contracts, rate of return -50.83%.

Example 3: Long November Soybean Futures

• Initial price $12.60, increase by 5%.
• Profit per contract $3,150, margin deposit $3,500.
• Rate of return ~90%.

Example 4: T-Bond Futures

• Expected yield rise, short at 88-24/32, liquidate at 90-20/32.
• Loss $1,875 per contract, commissions $40.
• Total loss for 10 contracts $19,150.

Example 5: T-Bill Contracts

• Expect interest rate decline, long at 92.05, liquidate at multiple prices.
• Profit $1,150 overall, multiple prices require breaking into separate trades.

Activities

• Calculating required price move for a specified profit/loss.
• Example: Silver Futures, Corn Futures.

Recommendations

• Practice with custom exams focusing on speculation problems.
• Aim for accuracy and efficiency in problem-solving.

Next Topic

• Commodity Futures Spreads