BASICS OF FUTURES INVESTMENT, MARGIN, TRADING RISK, NFA & CFTC

THE BASICS OF FUTURES TRADING

● Futures Trading Opportunities
❍ What Is a Futures Contract?
❍ What Are the Mechanics of a Futures Trade?
❍ Making a Futures Trade
❍ Price Risk Management
❍ Offsetting Contracts
● Who Uses Commodity Futures?
❍ How are Futures Brokers Regulated & Licensed?
❍ How Can an Investor Determine That His Broker Is Properly Registered With the NFA &
CFTC?

FUTURES TRADING OPPORTUNITIES

Futures trading offers tremendous opportunities for investors with the capital to risk. Futures speculators
invest in commodity futures in the same way others invest in common stocks, bonds, and real estate. The
primary purpose of futures markets is the same as It has been for the last century and a half - to provide
an efficient and effective mechanism for the management of price risks. Futures traders accept price risks
from producers and users with the idea of making substantial profits. After careful analysis of market
factors, the speculator invests risk capital to take advantage of price fluctuations.

WHAT IS A FUTURES CONTRACT?

A commodity FUTURES CONTRACT is a firm commitment to deliver or receive a specific quantity
and quality of a commodity during a designated month at a price determined by open auction on a futures
exchange.
For example, someone buying an April Gold contract at $345 an ounce is obligated to accept delivery of
100 ounces of gold during the month of April at a price of $345 an ounce. Someone selling an April Gold
contract would be obligated to deliver the same quantity and quality of gold at $345 an ounce.

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WHAT ARE THE MECHANICS OF A FUTURES TRADE?

As a buyer or seller of futures contracts, you must make an initial "good faith" deposit (margin). Since
contracts may be closed (liquidated) at any time prior to the "settlement" date, every futures position in
your account is marked-to-the-market (its value calculated at the close of each trading day) and
profits/losses are credited to/debited against your account. Any profits over the margin requirement may
be withdrawn or used for other futures contracts.
Futures traders exercise substantial leverage by utilizing a performance bond or MARGIN to control a
futures contract. Margin is money deposited by both the buyer and the seller to assure the integrity of the
contract. Minimum margins are set by the Exchange and are usually about 10% of the total value of the
contract. Details concerning customer margin requirements can be obtained from a broker. In this way
investors realize full price movements without investing the full amount of capital which each contract
represents.
A futures margin deposit is not the same as margin on stock purchases. Both margins secure your
purchases or sales, but they differ in many ways. Stock market margins are a form of down payment for
the purchases of an asset. A futures margin is more of a performance pledge, ensuring that obligations
will be honored. Since a futures deposit isn't an extension of credit (like a stock margin is), you may earn
interest rather than pay it. Moreover, while a stock margin is typically 50% of the value of the purchased
assets, a futures margin generally ranges from 5-10% of the contract value.

MAKING A FUTURES TRADE

Futures contracts are traded through Futures Commission Merchants (FCMs) or commodity brokers.
These individuals are licensed through the Commodity Futures Trading Commission (CFTC), a
regulatory agency of the federal government.
When you have satisfied the financial requirements set by the brokerage firm, a futures trading account
will be open in your name. Through your broker you are then able to make a commodity futures trade.
Pacific Rim Futures and Options (Pacific Rim), through R.J. O'Brien & Associates, Inc., can make
trades for clients on all major commodity exchanges.
Commodity brokers will charge a commission for executing your trade. The commission constitutes the
only major cost of buying and selling a contract. Managed commodity accounts may also be charged
management fees and/or percent of profit fees. Our brokers can supply you with our commission
schedule.
At the end of each trading session, all trades are checked and balanced with the Clearing House, which
becomes the guarantor of all trades. In effect, the Clearing House becomes the buyer for every seller and
the seller for every buyer. Therefore, the Clearing House insures both sides of every futures transaction.

PRICE RISK MANAGEMENT

Downward or upward shifts in the demand or supply of a commodity can result in PRICE
VOLATILITY. Price volatility creates financial risk for users and suppliers of a commodity. Anyone
whose business depends on a volatile commodity has a real need to manage price risk in order to insure

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continued profitability.
Standardized contracts for the delivery of a commodity are exchanged (traded) in the trading pit. The
price of contracts is determined through competitive bids and offers, a process called OPEN OUTCRY.
The purchase of futures contracts offsets the obligations to deliver the actual commodity by later selling a
contract for delivery in the same month. The vast majority of futures contract obligations are met by
taking such offsetting positions.

OFFSETTING CONTRACTS
In practice, only a small percentage of futures contracts traded are actually held to delivery. Maturing
futures contracts expire on specific dates during the contract month. Your broker can supply you with
expiration dates. At any time before the month the contract matures, the trader may close out his
obligation through an opposite or offsetting trade. By offsetting a futures contract, the trader cancels any
obligation he has to take delivery of the underlying commodity.
For example, the buyer of an April Gold contract can sell that contract before April. The difference
between the price when the trade was initiated and the price when it was offset is the gain or loss on the
trade.

WHO USES COMMODITY FUTURES?

There are two reasons to use commodity futures contracts: 1. To hedge a price risk, and 2. To speculate
in the changing price.
A HEDGER is someone who owns or plans to purchase an inventory of a commodity and wishes to
reduce risk associated with this ownership. Hedgers make their purchases or sales solely for the purpose
of establishing a known price level in advance for something they later intend to buy or sell in the cash
market. They do this by taking an equal and opposite position in the futures market than they have in the
cash market. As the price of the commodity fluctuates, the hedger is protected because gains in one
market are offset by losses in the other market, regardless of which direction the price moves. Hedgers
willingly give up the opportunity to benefit from favorable price changes in order to achieve protection
against unfavorable price changes.
SPECULATORS, on the other hand, are willing to accept the risk the hedger wishes to relinquish.
Speculators take positions on their expectations of future price movement often with no intention of
making or taking delivery of the commodity. They buy when they anticipate rising prices and sell when
they anticipate declining prices. The speculator provides a very important function in the futures market
because without him, the market would not be liquid and the price protection sought by the hedger would
be very costly.

HOW ARE FUTURES BROKERS REGULATED & LICENSED?

All futures industry related operations and personnel are strictly regulated and licensed by the CFTC - a
federal agency operating at the direction of Congress. This agency is analogous to the Securities &
Exchange Commission (SEC) that regulates stock exchanges and personnel.

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 BASICS OF FUTURES INVESTMENT, MARGIN, TRADING RISK, NFA & CFTC

The CFTC has transferred many of its regulatory powers to the NFA. The NFA has been designated as a
"registered futures association" under the provisions of the Commodity Futures Trading Commission Act
of 1974. The NFA officially began operations on October 1, 1982.
The primary purpose of the NFA is to ensure, through self-regulation, high standards of professional
conduct and financial responsibility on the part of the individuals and organizations that are its members:
Futures Commission Merchants, Introducing Brokers, Commodity Trading Advisors, Commodity Pool
Operators, and Associated persons of any of the foregoing.
In connection with its regulatory responsibilities, the NFA conducts periodic audits of its members'
financial and other records, monitors sales practices and provides a mechanism for the arbitration of
futures related disputes between NFA members and the investing public. Information regarding these
activities can be obtained by writing or phoning the NFA.

HOW CAN AN INVESTOR DETERMINE THAT HIS BROKER IS

PROPERLY REGISTERED WITH THE NFA & CFTC?
Anyone sending their money to an investment company should know that the firm they are going to do
business with is legitimate and is properly registered and licensed.
To check our registration, or any other commodity futures company or personnel, you may call or write
to:
National Futures Association Commodity Futures Trading
Commission
200 West Madison Street 2033 K Street Northwest
Chicago, Illinois 60606 Washington, D.C. 20581
(312) 781-1300 (202)254-8630
(800) 621-3570
Pacific Rim's parent, Pacific Rim Asset Management, Inc., is registered with these regulatory agencies
as:
1. An Introducing Broker, and
2. A Commodity Trading Advisor.

rpotts@teleport.com or phone 800-444-3684 (241-0107 in the Portland calling area) and ask for
Richard. If FAX is more convenient, you may FAX your request to Richard at 503-241-1015.
This page, and all contents, are Copyright © 1997 by Pacific Rim Asset Management, Inc., Portland,
OR
Last modified: 970101

Disclaimer: This document in no way represents Teleport, Inc. All opinions and errors
are mine alone.

rpotts@teleport.com

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