A futures contract is an agreement to deliver a particular commodity, such as wheat, pork bellies, or coffee, at a specific date, time, and place. For example, a farmer might sell his oats before they are sowed (known as hedging) because he or she cannot predict what kind of price he will be able to demand later on. If the weather is favorable and crops are good, the farmer will have competition, which will drive prices down. If there is a flood or drought, oats will be scarce, driving the price up. The farmer wants to ensure a fair price to protect the business and limit risk, because the future is uncertain.
On the other side of the equation is the user of the oats, perhaps a cereal manufacturer, who purchases these contracts for a delivery of oats at some future date. Producers and users do not correspond to a one-to-one ratio, and the broker is a middleman who does the buying and selling of contracts between the two groups. Brokers may place orders to buy or sell contracts for themselves, for individual clients, or for companies, all of whom hope to make a profit by correctly anticipating the direction of a commodity's price. Brokers are licensed to represent clients, and brokers' first responsibility is to take care of their clients' orders before doing trading for themselves. Traders also buy and sell contracts for themselves. Unlike brokers, however, they are not licensed (and thus not allowed) to do this work for clients.
When placing a trade for others, brokers are paid a fee or a commission for acting as the agent in making the sale. There are two broad categories of brokers, though they are becoming less distinct. Full service brokers provide considerable research to clients, offer price quotes, give trading advice, and assist the customer in making trading decisions. Discount brokers simply fill the orders as directed by clients. Some brokers offer intermediate levels of optional services on a sliding scale of commission, such as market research and strategic advice.
In general, brokers are responsible for taking and carrying out all commodity orders and being available on call to do so; reporting back to the client upon fulfilling the order request; keeping the client abreast of breaking news; maintaining account balances and other financial data; and obtaining market information when needed and informing the client about important changes in the marketplace.
Brokers can work on the floor of a commodity futures exchange—the place where contracts are bought and sold—independently or for a brokerage house. There are fewer than 10 domestic exchanges, with the main ones in Chicago, New York, and Minneapolis.
To be allowed to work on the floor, a broker must have a membership (also known as a "seat") in the exchange or must be employed by a company with a seat in the exchange, which is a private organization. (Although a few exchanges require brokers to purchase licenses to trade, rather than purchase a seat.) Memberships are limited to a specific number, and seats may be rented or purchased. Although seat prices vary due to factors such as the health of the overall economy and the type of seat being purchased, they are all extremely expensive. Seat prices can range from tens of thousands of dollars to hundreds of thousands of dollars (full seats have been known to sell for $700,000 and more). Naturally, this expense alone limits the number of individuals who can become members. In addition to being able to afford a seat, candidates for membership to any exchange must undergo thorough investigations of their credit standing, financial background, character, and understanding of trading.
Most brokers do not have seats but work for brokerage houses that deal in futures. Examples of these houses include Merrill or Morgan Stanley, which deal in stocks, bonds, commodities, and other investments, and smaller houses, such as R. J. O’Brien and Associates LLC that handle only commodities.
Companies can also have a seat on the exchange, and they have their own floor brokers to carry out trades for the brokerage house. Brokers in the company take orders from the public for buying or selling a contract and promptly pass it on to the floor broker. Specialists or market makers also work on the exchange floor. According to the U.S. Department of Labor, "there is generally one for each security or commodity being traded. They facilitate the trading process by quoting prices and by buying or selling shares when there are too many or too few available." Brokers also have the choice of running their own business. Known as introducing brokers, they handle their own clients and trades and use brokerage houses to place their orders. Introducing brokers earn a fee by soliciting business trades, but they don't directly handle the customer's funds.
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