AREc 444/544 COMMODITY FUTURES AND OPTIONS MARKETS (4 Credits)

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1 AREc 444/544 COMMODITY FUTURES AND OPTIONS MARKETS (4 Credits) Instructor Thorsten M. Egelkraut 200B Ballard Extension Hall phone (541) Please set up an appointment by if you want to discuss questions with the instructor via phone. answers will necessarily have to be very brief. Course Description The course will provide an overview of the basic concepts needed to use commodity futures and options markets to successfully manage price risk. To address the increasingly global economy in which commodity transaction occur, the course also includes financial futures and options such as interest rates and currencies. Specific topics covered include contract standardization, speculation and hedging, opening and closing of positions, and basis, i.e. the relationship between cash and futures markets, input-output hedges, spreads, and pricing. The students will also gain hands on experience through a trading simulation. Course Structure This is an upper level course, but freshmen, sophomores, juniors, and graduate students are welcome to register as long as they have an interest in the subject. Yet, because it is an upper level course, students are expected to display a great deal of independence and maturity. If questions emerge, the first step towards finding the needed information should involve the library (and/or the internet), the second the instructor. Students are expected to be prepared when asking questions and post sufficiently early. Students who don't do the homework or don't attend class regularly will likely do poorly on the tests, and obviously cannot contribute to the class discussion. Course Delivery This course will be delivered via Blackboard, your online learning community, where you will interact with your classmates and with me. Within the course Blackboard site you will access the learning materials, practice problems, homework and syllabus; discuss issues; submit assignments; take exams; and other students. 1

2 To preview how an online course works, visit the Ecampus Course Demo. For technical assistance, Blackboard and otherwise, see Learning Outcomes At the end of this class students will be able to 1) use commodity futures and options markets to manage price risk and 2) have acquired the conceptual groundwork to continue learning on their own about other and more advanced derivative instruments such as swaps etc. 3) Aside from the mechanics of commodity futures and options markets, students will develop their economic intuition by a) thinking through how markets work, b) analyzing price movements, c) simulated trading, and d) building and assessing more complex trading strategies such as input/output hedges. Graduate students: In addition, graduate students will develop in-depth expertise beyond the material covered in lecture about a specific commodity markets topic of their interest. The topic must be agreed upon and approved by the instructor. The graduate project will result in a written paper (max. 20 pages single spaced, graded based on content, clarity, and professional writing). Prerequisites Grading There are no formal prerequisites for the course, yet students should have an intuitive understanding of fundamental microeconomic concepts. Though the prerequisites are rather minimal, please note that this does not mean the course is easy. In fact, the course is rather challenging. While the concepts are taught, you must apply a good amount of logical economic thinking in order to achieve the learning goals. However, mathematics are limited to adding and multiplying. The grade scale below takes the level and nature of the course into account. The final grade for the course consists of 1,000 points allocated as: A. Homework (200 points total). Several homework problems will be given during the 10 weeks of classes. Homework assignments need to be submitted online by the due date posted. Homework will be given a zero grade if not turned in when due and graded on a pass/fail basis. I want the homework to be a stress free, positive, and enjoyable learning experience for the students. As long as all problems posed are solved you will receive a pass (independently of whether the solution is ultimately correct). The homework will provide experience in using the futures market to manage price risk. Homework will not be returned but instead I will walk the class through the solution after the due date. 2

3 B. Trading Simulation (50 points). Throughout the term, students will participate in a trading simulation. C. Exams (750 points). Three announced exams, two midterms (250 points) and one final (250 points), will be given. The tests will be conducted online and be true/false and multiple choice and cover material discussed in class and techniques learned by doing the homework. All exams are comprehensive. D. Graduate students enrolling in the course will also be expected to complete a special project. The point system listed above will be modified to allow this additional requirement to account for 20% of the final grade. Grading Scale A = A- = B+ = B = B- = C+ = C = C- = D+ = D = D- = F = below 60.0 Take this course only if you plan to finish it in a timely manner (during this term). I assign an "I" or incomplete only when there is a strong and compelling case for doing so (e.g., health reasons, military commitment). I will not consider assigning an incomplete unless the individual has completed half of the homework and at least two exams. Please note that students receiving incompletes are subject to university regulations and that their grade may automatically revert to an F if the course is not completed within a year s time. I consider myself a fair grader, but I do not believe in grade inflation. You get the grade you earn. I do not curve. Course Material R.M. Leuthold, J.C. Junkus, and J.E. Cordier, The Theory and Practice of Futures Markets. Lexington Books, Stipes Publishing, 2 nd Rev Edition, (optional, the book is somewhat dated but overall does a good job covering the material of this course) A course pack will be posted online and can be printed off. The lecture will closely follow the course pack. 3

4 Part of the course is a trading simulation, which will provide valuable trading experience. The provider charges a fee of 35,-US$ per sign-up for this simulation, which students pay directly via paypal or credit card. The trading simulation is conducted online via the internet, and more information can be found by visiting the following website: The instructor will provide an explanation and introduction to this trading simulation as well as details regarding the signup in class (do not sign up until you have accessed those additional directions). Study tips 1) Read the notes for each lecture ahead of time, try to understand them, and try some of the practice problems. 2) View the lecture. Do not skip in-class assignments. 3) Go over the lectures notes after viewing the session. Cover up the examples solutions and attempt them again on your own. Study consistently every day and do not cram all at once. Do not give up too easily but push yourself and your own thinking. 4) Participate in the discussion board. 5) For the trading simulation: Do read a few market reports for your commodity daily (10-15 min). This will help you learn how the market thinks and provide a real world reference for your own analysis, did the market think the same way you did? What did you miss? etc. Moreover, reading the market commentaries will familiarize you with the language used in the commodity futures of your choice. Course Outline The first few lectures will introduce the basic concepts of futures markets with subsequent lectures building upon these fundamental concepts and introducing various applications. In this course it is very important that students do not fall behind but continuously stay on top of the material. Once behind, it is extremely difficult to catch up. The best strategy is to not lag the class. The schedule below outlines the course, small adjustments may be necessary to take into account students learning progress as well as current events. Any adjustments will be announced. Date Content Week 1 Lecture 1 Course introduction, syllabus, commodity markets, standardization, futures contracts Lecture 2 Contract specification, futures price quotes, hedging, volume, open interest 4

5 Homework 1 due before lecture 3 Lecture 3 Entering and exiting futures positions, hedging examples, importance of speculators, margins Week 2 Lecture 4 Margins, order types, introduction of trading simulation Homework 2 due before lecture 5 Lecture 5 Functioning of futures exchanges, importance of clearinghouse, basis Lecture 6 Cost of carry relationship, spreads Homework 3 due before lecture 7 Week 3 Lecture 7 Rolling hedges, currency futures Lecture 8 Equity index futures Homework 4 due before lecture 9 Lecture 9 Review Exam 1 Week 4 Lecture 10 Discuss Exam 1 Lecture 11 Optimal hedge ratio, cross hedging, hedging effectiveness Lecture 12 Input-output hedges Homework 5 due before lecture 13 Week 5 Lecture 13 Processing hedges application Lecture 14 Crack-spread Homework 6 due before lecture 15 Lecture 15 Interest rate futures, implied forward rate Week 6 Lecture 16 Hedging interest rates, interest rate spreads Homework 7 due before lecture 17 Lecture 17 Fundamental analysis Lecture 18 Technical analysis Homework 8 due before lecture 19 Week 7 Lecture 19 Review Exam 2 Lecture 20 Discuss Exam 2 Lecture 21 Introduction to options, option characteristics, intrinsic value, time value Week 8 Lecture 22 Entering and exiting options positions, payoff diagrams, hedging with options Homework 9 due before lecture 23 Lecture 23 Option writing as part of pricing strategy Lecture 24 Fencing in a price range with options Homework 10 due before lecture 25 Week 9 Lecture 25 Option pricing, put-call parity Lecture 26 Black-Scholes option pricing model Homework 11 due before lecture 27 Lecture 27 Delta hedging Lecture 28 Synthetic positions, straddles, options spreads Homework 12 due before lecture 29 Week 10 Lecture 29 Hedging applications, interest rate options Lecture 30 Review Exam 3 (final) Reading outline for the optional textbook (This is only a guide; the textbook covers additional topics, many of which are also covered in class, and students should consult the book s table of content to find the corresponding sections in the book. Also, for further readings there is a small number of other text books on the subject as well as material on the internet.) 5

6 Futures Trading and Commodity Exchanges Course introduction, expectations, discussion of syllabus Introduction to futures and options markets History and Evolution of global commodity futures and options markets Readings: chapters 1, 6, p & , glossary Exchanges and Commodities Clearing of futures and options contracts Readings: chapter 2 Mechanisms of Futures Trading Price Relationships, storable commodities Price Relationships, non-storable commodities Readings: chapters 3, 7 Pricing Currency Instruments Spread Relationships Readings: chapters 4, 9, p & & Risk Management: Futures Markets Definition of Hedging Readings: chapter 4, p Business and Currency Risk Dealer and Merchant Use of Futures Readings: chapter 8 Primary Producer Use of Futures Processor Use of Futures Readings: chapter 8 Multiple Commodity Hedging Optimal Hedging, Review Readings: chapter 5, 79-81, Use of Currency Instruments Input-Output Hedge Readings: chapter 10, 11, p & & Speculators, Methods, and Returns Price Performance and Behavior Readings: chapter 4, 6, p , Market Regulations Market Regulation Readings: chapter 14 Options on Futures Terminology of Options and Their Mechanisms Readings Chapter 13: p The Uses of Buying Puts and Calls Calls, Puts, Writing Puts and Calls Readings: Chapter 13: p

7 Pricing of Options Readings: Chapter 13: p Students with Disabilities Accommodations are collaborative efforts between students, faculty and Disability Access Services (DAS) with accommodations approved through DAS are responsible for contacting the faculty member in charge of the course prior to or during the first week of the term to discuss accommodations. Students who believe they are eligible for accommodations but who have not yet obtained approval through DAS should contact DAS immediately at Academic Integrity Students are expected to comply with all regulations pertaining to academic honesty, defined as: An intentional act of deception in which a student seeks to claim credit for the work or effort of another person or uses unauthorized materials or fabricated information in any academic work. For further information, visit Avoiding Academic Dishonesty, or contact the office of Student Conduct and Mediation at Conduct in this online classroom Students are expected to conduct themselves in the course (e.g., on discussion boards, postings) in compliance with the university's regulations regarding civility. Students will be expected to treat all others with the same respect as they would want afforded themselves. Disrespectful behavior to others (such as harassing behavior, personal insults, inappropriate language) or disruptive behaviors in the course (such as persistent and unreasonable demands for time and attention both in and out of the classroom) is unacceptable and can result in sanctions as defined by Oregon Administrative Rules Division 015 Student Conduct Regulations. Ground Rules for Online Communication & Participation Online threaded discussions are public messages, and all writings in this area will be viewable by the entire class or assigned group members. If you prefer that only the instructor sees your communication, send it to me by , and be sure to identify yourself and the class. Posting of personal contact information is discouraged (e.g. telephone numbers, address, personal website address). Online Instructor Response Policy: I will check frequently and will respond to course-related questions within 48 hours. However, do not me with general questions that force me to write an elaborated response. These are better suited for the discussion board or an appointment via the phone. Observation of "Netiquette": All your online communications need to be composed with fairness, honesty and tact. Spelling and grammar are very important in an online course. What you put into an online course reflects on your level of professionalism. Here are a couple of references that discuss o writing online: o netiquette: Please check the Announcements area and the course syllabus before you ask general course "housekeeping" questions. If you don't see your answer there, then please contact me. 7

8 Guidelines for a productive and effective online classroom The discussion board is your space to interact with your colleagues related to current topics or responses to your colleague s statements. It is expected that each student will participate in a mature and respectful fashion. Participate actively in the discussions, having completed the readings and thought about the issues. Pay close attention to what your classmates write in their online comments. Ask clarifying questions, when appropriate. These questions are meant to probe and shed new light, not to minimize or devalue comments. Think through and reread your comments before you post them. Assume the best of others in the class and expect the best from them. Value the diversity of the class. Recognize and value the experiences, abilities, and knowledge each person brings to class. Disagree with ideas, but do not make personal attacks. Do not demean or embarrass others. Do not make sexist, racist, homophobic, or victim-blaming comments at all. Be open to be challenged or confronted on your ideas or prejudices. Technical Assistance If you experience computer difficulties, need help downloading a browser or plug-in, assistance logging into the course, or if you experience any errors or problems while in your online course, contact the OSU Help Desk for assistance. You can call (541) , [email protected] or visit the OSU Computer Helpdesk online. OSU Student Evaluation of Teaching Course evaluation results are extremely important and are used to help me improve this course and the learning experience of future students. Results from the 19 multiple choice questions are tabulated anonymously and go directly to instructors and department heads. Student comments on the open-ended questions are compiled and confidentially forwarded to each instructor, per OSU procedures. The online Student Evaluation of Teaching form will be available toward the end of each term, and you will be sent instructions by Ecampus. You will login to Student Online Services to respond to the online questionnaire. The results on the form are anonymous and are not tabulated until after grades are posted. 8