Introduction
Farm managers planning to use futures and options as part of their marketing plan must use a commodity broker to buy and sell their futures and options. An experienced broker, also known as a Futures Commission Merchant (FCM), can be a very valuable asset to the farm manager.
Step One
The first step in choosing a FCM is deciding what level of service and advice is needed. Some farm managers want a broker whose firm provides market background and outlook information. Other farmers do not need that because they get their market information from other sources. Trading costs are normally higher for companies who provide additional services.
Step Two
The next step in choosing a broker involves talking to several firms and their brokers either by phone or in person. Talking to several firms helps you make a choice based on each firm's required financial conditions and level of service. Talking to more than one broker at each firm helps you choose a broker that you are comfortable with on a personal level, which is also important.
Some firms have several FCMs in their offices. Often each FCM has a different area of interest. Some deal mostly in industrial commodities or financial futures, while others concentrate mostly on agricultural commodities.
Client protection
FCMs who accept futures and options trade orders on behalf of Alberta farmers must be registered with the Alberta Securities Commission or with the Investment Dealers Association, or both. These registrations require that each FCM follow certain accounting standards and procedural practices and that the firm is financially secure. Each firm must file quarterly and annual financial statements. A chartered accounting firm also audits each firm annually.
Types of brokers
Clearing brokers
A clearing broker is employed by a company that has the right to trade directly on the various commodity exchanges. That means the firm's own traders carry out futures and options buy and sell orders directly in the market on behalf of customers.
The clearing broker also maintains margin accounts directly with the futures exchanges and is directly responsible for ensuring adequate funds are maintained in these accounts and if not, ensures the customer acts on margin calls.
Introducing broker
An introducing broker takes futures and options orders from customers and relays them to a clearing firm to have the orders filled at the exchanges. The introducing broker also uses the clearing firm for depositing funds and ensuring that margin requirements of the exchanges are maintained.
If an introducing broker goes out of business, the clearing broker handles customer futures and options positions.
How trades are done
On behalf of a farm manager, a FCM with a clearing firm may either submit a trade through the firm's trading software system or phone the order to the brokerage house order desk. An introducing broker will transmit trades through the head office of his or her clearing broker. Some brokerage firms will provide a software platform to clients who may then directly place their own trades. Canola trading at the Intercontinental Exchange (ICE) is done on an electronic platform based at their New York Exchange.
There are also overnight trading sessions available for both ICE and CME Group exchanges. CME livestock futures, on the other hand, trade only during the daytime hours as there is no overnight electronic session.
Client financial requirements
FCMs often require their customers to meet certain financial conditions before the firm will agree to accept futures or options contract orders. Clients may be required to have a certain minimum gross income or net worth. A minimum operating line of credit or bank cash deposit may also be required. These conditions are in effect to protect FCMs from clients who are financial unstable.
Some of these guidelines may be reduced or waived under certain conditions, especially for clients who only plan to hedge in their trading accounts. Farm managers, who are talking to prospective FCMs, should ask for details of each firm's client financial requirements before choosing to use a firm's services.
Broker checklist
Good commodity brokers:
- understand farming and what a farm manager is trying to accomplish by hedging
- are knowledgeable about the markets without being overwhelming or overbearing
- keep their clients informed about the market and the conditions of their accounts
- do not pressure clients, who are primarily interested in hedging, to speculate
- have good personal contacts in the marketplace for agricultural commodities; contacts may provide background information on market news that is not otherwise readily available
- do not necessarily offer the lowest commissions. Generally, commissions are not a high-cost item. Compare all services offered by various companies before choosing a firm based on low commission.