chapter 7 speculation this is a crucial chapter for the series 3 there's two big sections of market knowledge that people sometimes struggle with speculation and hedging in both of those sections you'll see a lot of problems so here in the speculation section there'll be a lot of calculations where you'll figure out either the profit or loss on the trade or maybe the percentage profit or loss and remember when you taking the test the time may be a factor so it's not only important that you can get the right answer but you have to be able to get it efficiently and that should be a big goal in your preparation that you can handle these speculation problems efficiently so you're not Reinventing the wheel for every one of these questions because there are about 16 speculation questions on their test so this is an important part of that market knowledge that General market knowledge section of the exam speculators will buy and sell for the purpose of making a profit and some people say well of course doesn't everybody do that and the answer is not really hedgers remember will buy or sell to reduce the risk of their cash position so hedgers are really using Futures not to profit on the Futures but as a offset as an offset to a cash position so hedgers are using Futures to avoid risk speculators are using Futures to try to profit if you expect the price to rise then you go long the Futures you buy or go long the Futures if you expect the price to fall you can profit from that you short the Futures you sell Futures that you eventually buy back when you short the Futures you're hoping that the price will drop you'll be able to buy it back at a cheaper price later on and you'll make money that way so you can make money whether you think the Market's going up or down now remember a couple of word questions what is the most important thing that speculators add to the market they add liquidity liquidity is the ability to get in or out of a position at a reasonable price well speculators add liquidity if the market only allowed for hedgers then there would not be great liquidity in the Futures market so the speculators are willing to take that other side risking their capital and attempt to profit and that provides more participants and makes the markets more liquid what that liquidity has been shown to do is to reduce volatility so the existence of speculators actually reduces price volatility because they're adding liquidity to the market market now when we do speculation problems on the test you'll have to factor in commissions for the vast majority of them now commissions could be given to you as total commissions for the entire position but way more likely is they'll give you what's called round turn commissions now when they tell you round turn commissions were $40 what does that mean it includes the price of not only establishing the position but also liquidating the position so it includes the cost of both the purchase and the sale but it's per contract but it's per contract so if the test tells you round turn commissions were $40 that means that's the cost of buying and selling the contract but it's per contract so if you did five contracts and round term commissions were $40 then the total commissions would be $200 because it's $40 per contract now if you see the term half turn commission that would only include one of the transactions so either buying or selling round turn includes both buying and selling but again it's per contract if they said total commissions for the five contracts you traded were $300 $ then that would be the total commissions paid for all the trades now every speculation problem can really be set up the same way we go long at a price or short at a price we offset the position in a price that will give us a profit or loss per unit maybe per ounce of gold or per bushel of wheat or per barrel of crude so we establish the position at one price we liquidate at another price and that gives us a profit or loss per unit if you multiply that by the contract size you get the total profit or loss per contract but then we have to factor in commissions because most of the speculation problems on the series 3 will bring up commissions so how do we factor in commissions well if you have a profit the commissions make your profit smaller so if you made $1,000 but paid $40 in commissions then you made $960 but make sure you don't make a kellish mistake commissions make losses even bigger losses so if you had a $1,000 loss and you paid $40 in commissions then notice your loss is $1,040 so commissions make our profit smaller but commissions make our losses even bigger losses then don't forget the number of contracts that you did most questions on the series 3 will have you do multiple contracts so don't forget that possible last step of you figure out your profit or loss per contract you look down and there's an answer that matches before you just pick that answer be careful did you factor in the number of contracts you did so let's take a look at a speculation problem and we'll figure out not only the profit or loss but also the percentage profit or loss which we're calling here the rate of return the percentage profit or loss on the trade some of the speculation problems will bring it out that extra step on your actual series three so an investor who is bullish on May wheat takes a long position when the price of May wheat is at 510 the contract size is 5,000 Buel the investor later offsets when the price is$ 550 if round turn commissions are $50 an initial modin is 50 cents per bushel what's the Investor's rate of return so let's take a look at this question the investors bullish they take a long position at 510 so they buy at 510 the investor later offsets when the price is 550 so they sell it they liquidate it at 550 so our first step step is how did we do per in this case bushel well we bought at 510 sold at 550 so notice we made 40 cents a Bushell how many bushels in a contract 5,000 bushels in a contract so we made 40 cents a bushel times 5,000 bushels in a contract we made a total of $2,000 per contract but then they do give us commissions round turn commissions are $50 so commissions will subtract from that profit so we paid $50 in commissions so our net profit is $1,950 and since we only did one contract our total profit on this trade is $1,950 now what if they asked us our percentage profit or loss then we have to factor that in to the initial margin requirement they tell us here our initial margin is 50 Cent a Bushell time 5,000 belel gives us a margin requirement of $2500 so notice we made $1,950 on a margin deposit of $2500 so we have a 78% profit so notice un less than a 10% move right it we went long at 510 and it only moved by 40 C notice how much we made 7 8% that is because of that leverage we're controlling $510 worth of wheat for a deposit of0 50 cents per bushel let's take a look at another example now that first example I would say was a very easy speculation problem but as we move along we'll get into more difficult ones this one is a bit more difficult this one is very typical of many types of question questions you'll see on the series 3 and by the time we're done with this speculation chapter we will have done the most difficult types of speculation questions you'll see on your entire series three so let's take a look at this one a Trader believes that July corn Futures will fall therefore he or she shorts three contracts at 675 now the way the test might have given you this lead in is it might have said a Trader believes July cor futures fall and takes the appropriate position in three contracts well if you expect the price to fall the appropriate position would be to short the Futures so we're shorting them at 675 the contract size is 5,000 buels when the price has risen to 705 the trader offsets the contracts so the first step is do we have a profit or a loss well we shorted them at 675 we buy them back at 705 we have to pay more so we have a loss of 30 per Bushell we multiply that by the contract size of 5,000 bushels and we get our loss of $1,500 per contract but that doesn't factor in commissions yet we have to factor in commissions if round turn commissions are $25 then we lost $1,500 and paid $25 in commissions that adds to our loss of, 1500 and we've lost 1525 per contract now if the question was just asking what was the total loss don't forget we would take that $1,525 and multiply it by the three contracts that we shorted so we lost 1525 per contract times three contracts so we lost $ 4575 on the trade but here they're asking us what's the percentage profit or loss the rate of return so we have an initial margin requirement of 60 cents a Bushell time 5,000 bushels our margin requirement is $3,000 that's our margin requirement per contract our total margin requirement would be $9,000 because notice we shorted three contracts since they're just asking for the percentage profit loss we could actually just do the percentage profitable loss on one contract and it would be the same as the percentage profitable loss on threee contracts so we had a loss of 1525 on a deposit of $3,000 which gives us a percentage loss of 50.83 per. notice if you did it based on the total loss it would come out the same way we had a total loss on the three contracts of 4575 on a total margin deposit of $99,000 giving us the same percentage loss of 50.83 let's take a look at another example now that first question I would say was an easy question the second question a bit more challenging this third question just shows you another way that the questions can be worded and again feel free to pause the video and give it a try before we even do it together no November soybean Futures are trading at 1,260 cents per Bushell notice right there people get they stop a little bit and say 1,260 cents per bushel yes that's the way some Commodities are quoted if you want one of the easier ways to handle these questions is converted into dollars right away by moving the decimal point two places to the left so notice 1260 is the same as $12.60 the contract size is5 ,000 bushel and the initial margin requirement is $3,500 per contract an investor establishes a long position in the November contract at the current price later she liquidates her position when the November soybean Futures have increased by 5% what is the Investor's rate of return so notice here they don't tell us where the price went except by telling us she liquidates when the prices increased by 5% so we just have have to figure it out ourselves so we went long at 12260 or another way of saying that is $12.60 we liquidate when it's increased by 5% 5% * 1260 means there was a 63 C increase so what is that profit we multiply that by the contract size of 5,000 bushels and that gives us a profit per contract of 3150 $ 63 cents a bushel time 5,000 bushels now this question is saying what's the rate of return or the percentage profit or loss so we have to make that a percentage of the margin requirement what's the margin deposit it's $3500 in initial margin so we made $3,150 on a $3,500 deposit or we made roughly a 90% rate of return now these next two question questions look at the financial Futures and these are the ones that are probably the trickiest for people so here I remind you that we had the long-term financials and the short-term financials the long-term financials were quoted in points and 30 seconds of a point the short-term financials were quoted in points and basis points okay and if you forget that it's worth reviewing that initial slide where we discussed how the long-term and short-term financials are priced because it does come up quite a bit on the test so let's take a look at this question an investor expects yields on t-bonds to rise and takes the appropriate position in 10 September t-bond Futures at 888-244-1702 trade well this question I would label as a pretty difficult question on your actual Series 3 okay because it does involve something that's a little bit more complex for most people which are the financial Futures and notice they don't tell us the contract size we just have to know how much each point and each 30 second is worth notice they don't even tell us that these t-on Futures are quoted in 30 seconds of a point so that quote of 80 8-24 represents what 88 and 24 302s the next thing that people have trouble with is the whole idea of whether we went long or short so should the investor take a long or a short position so let's see what they tell us an investor expects yields on t-bonds to rise yields and interest rates are basically the same thing interest rates up or yields up bond price is down so do we go long or short we go short the contracts so we went short the contracts at 88 and 2430 seconds notice we need to know that these are in 30 seconds when we liquidate we buy them back but it cost us more it cost us 90 and 20 30 seconds so notice here we have a loss of that difference now here's the next thing that gives some people trouble they can't do the math that quickly or easily so we want to take 88 and 24 302s away from 90 and 20 302s the problem is you can't take 24 30 seconds away from 20 30 seconds so we have to borrow a full point from the 90 it makes that 90 and 89 and add 32 302s to the 20 302s so 90 and 203 seconds is the same as 89 and 523 seconds now we can do the math we take the 88 away from the 89 and we get one and we take the 24 30 seconds away from 52 302s and we get 28 302s if you have trouble with that math again we did show you how to do that earlier on in the presentation so here notice we have a loss of 1 and 28 302s the next thing they don't tell us the contract size we have to know what that equals remember each full point equals $11,000 so the full point is $11,000 each 302 equals $31.25 so we had 28 302s * 3125 per 302 gives us $875 our total loss is $1,875 per contract now the other way you could have done this is we lost one and 28 302s per 1 and 28 302s per or 1.875 per of $100,000 why $100,000 that's actually the contract size it's a $100,000 T not or t Bond so that would give us the same $1 1875 most people just remember each full point is $11,000 each 302 is 3125 so we've lost lost $ 18875 per contract but then they gave us commissions on top of that we had commissions of $40 that brings our loss to $1,915 per contract that might be a choice on the test that is not the right answer it's asking for our total loss what's the Investor's profit or loss so notice we did 10 contracts so multiply it by the number of contracts 10 and we get our total loss of 19,1 $150 first of all I would star this question okay why because you'll see several questions just like this and if you can handle this one you could usually handle all the easier ones on the test so this is a great question for you to be very efficient at if you have trouble with it a great idea is to try to teach this slide to someone explain this slide teach it to them that's a great way to learn very important so we get our total loss of $1,150 now let's take a look at a shortterm financial future here we have the T Bill contract so the first thing to remember is when it's a short-term financial future we're dealing with points and basis points this question we're going to see also throws in another wrinkle that we don't just establish at one price and liquidate the whole thing at a different price we're going to have multiple prices to deal with so let's take a look an investor expects the interest rates to decline and takes the appropriate position in four t- Bill contracts at 9205 so the first question is what is the appropriate position if we expect interest rates to fall then we expect prices to go up so we go long the contracts so how many contracts do we go long here the investor expects interest rates to decline and takes the appropriate position in four t- Bill contracts at 9205 the investor later offsets three contracts at 9304 and liquidates the last one at 9314 so notice what they did to us here they didn't just give us one price where we liquidated all the contracts we liquidate three at 9304 and we liquidate the last one at 9314 what is the total profitable loss for this investor so how do we tackle this question where we're not doing it all at just establish at One Price liquidate the whole thing at a different price well again feel free to pause the video if you want to try it okay the way we would recommend doing this is break it into two trades we did four contracts at 9205 but since we later offset three at 9304 let's just treat that as we bought three at 9205 that we sold at9 9304 then we did one contract where we bought it at 9205 and liquidated at 9314 and just break it into those two separate trades so let's take a look at how to calculate that we went long at 9205 and we liquidated those three those first three at 9304 so we sell them at 9304 that gives us a profit of 99 now here's the next thing we have to remember this is short-term financials so we're dealing with points and basis points 99 is 99 basis points remember 01 is a basis point so 099 is 99 basis points what is each basis point equal $25 so we made 99 basis points time $25 per contract that gives us a profit per contract of $24.75 now how many times did we do that we did that three times which gives us a total profit on that trade of 7425 and notice here we didn't get commissions to worry about so we just ignore it now we also have that other contract we went long at 9205 we sold that one at 9314 giving us a profit of 1.09 and again the easiest thing to do is just convert it into basis points so that would be 109 basis points with each basis point worth $25 per basis point giving us a profit on that one contract of 2725 so our total profit we add them together since they were both profits and we have a profit of $1,150 in total so I would label this a very difficult question on the actual Series 3 but again a good question to know how to do you will get a couple where you have to deal with multiple prices like this now let's take a look at a couple of activities where they give you a profit or loss but have you back into what type of move is required to create this profit or loss and again with all the activities feel free to pause the video if you want to try it first okay let's take a look a client buys a ma silver Futures at $17.24 the initial margin on Silver Futures is $112,000 per contract and requires acceptance of 5,000 troy ounces 5,000 ounces of silver at what value does the May contract need to settle for the customer to realize a $5,000 profit so they're not asking us to calculate really a profit or loss given a movement they're saying for this investor to make $5,000 what move would be needed in this contract so the client buys May silver at 1724 where would it have to go for us to make $5,000 well for us to make $5,000 since the contract is 5,000 o we would have to make a dollar per ounce notice we want a $5,000 gain there's 5,000 ounces in a contract so we would need to make a dollar per ounce if we're buying at 1724 notice the question is asking at what value does the May contract need to settle for us to make 5,000 we need to make be make a dollar which means it has to get from 1724 up by a dollar to1 1824 so if it did we would up be up a do per ounce time 5,000 o we would be up $55,000 per contract let's take a look at one more activity that requires you to back in to the price move needed to make a certain amount of money and again feel free to pause the video if you want to try it on your own okay let's take a look a client sells a December cor Futures at 3119 A4 the initial margin on corn Futures is $1,500 per contract and it requires delivery of 5,000 pels of Corin at what value does the December corn contract need to settle for the customer to realize a $3500 profit so again they're asking us where would the contract have to go for us to realize a profit of $3500 well notice first of all that we are selling the coin futures so for us to profit we need the market to fall and how much do we want to make $3500 but each contract represents 5,000 bushels if we want to make $3500 then notice we don't need a dollar move because a dollar move on 5,000 bushels would give us a $5,000 profit we need some portion of that so how do we calculate it again to calculate it you take that total profit you want 3500 divide it by the contract size of 5,000 bushels and notice we need a 70 Cent move let's double check that by seeing if that would be right if we made 70 cents times 5,000 bushels notice that would give us a $3500 profit so yes it does work and that's a way you could always do these questions is back into what price move would result in the profit or loss that you're looking for so here obviously the profit so if it if we made 70 cents on 5,000 bushels yes that would give us a $3,500 profit so what do we need the contract to fall to well it started at 3194 or $319 A4 31925 we need to make 70 cents so we subtract that 70 c decrease that we need and we get we would need the contract to fall to $249 and A4 cents that would give us the 70 Cent decrease times 5,000 bushels would give us the $3500 profit so we would need the contract to move to $24 9 and A4 to give us that profit that completes the speculation section I strongly recommend that you create a custom exam on speculation now and apply what we looked at here to questions as you go through the questions remember your goal is not only to get the right answer but to get the right answer efficiently you have to be able to know exactly how to set up each speculation process problem and again there's a routine to it where do you go long or short where do you liquidate what's your profit or loss per unit multiply by the contract size and you get your profit or loss per contract factor in the commissions and you get your net profit or loss after factoring and commissions then if you have multiple contracts watch out multiply by the number of contracts to get your total profit or loss speculation a very important chapter create that custom exam do 10 15 speculation problems apply this knowledge what we'll look at next is commodity Futures spreads