Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Chicago Board of Trade (CBOT)

What it is:

The Chicago Board of Trade (CBOT) is a commodity futures and options exchange. Several dozen types of contracts trade on the CBOT, and the exchange facilitates hundreds of millions of these trades each year. Note that the CBOT is not the same as the Chicago Board Options Exchange (CBOE), which is primarily for stock options

How it works (Example):

The CBOT opened on April 3, 1848. On October 18, 2005, the CBOT became a for-profit business with shares listed on the New York Stock Exchange (NYSE: BOT).

The CBOT trades futures and options contracts for agricultural and financial products. The agricultural products include commodities such as flour, corn, rice, hay, soybeans, wheat, silver, gold, and ethanol. The financial derivatives include items such as emission allowances, interest rate swaps and futures, and Dow Jones index futures and options on futures.

CBOT traders buy and sell contracts by ainterest bidding or offering a price and a quantity of contracts. For most of the CBOT’s life, trading took place via open outcry in one of its many octagonal trading pits. The traders in the pit announce the number of contracts they want to buy or sell and the price they want to pay or receive. They use their fingers to denote the quantity of contracts. When the trader’s palm faces out, he is trying to sell contracts. When the trader’s palm faces in, he is buying. This open outcry system is one of the most well-known images associated with the financial world. In recent years, however, the CBOT has modernized and introduced electronic trading. Now investors can trade using either the open outcry or electronic method.

Like the New York Stock Exchange, one must have a membership to trade the various products listed on the exchange. Although the CBOT’s thousands of members can only trade via open outcry from 7:20 AM to 3:15 PM Monday through Friday, the CBOT’s electronic trading day is 22 hours long.

Why it Matters:

The CBOT and the futures market it facilitates is important because it gives its participants a way to manage risk. These participants, called hedgers, buy or sell futures contracts to protect themselves against unfavorable price changes (these people might be corn growers or bread companies for example). But there is another type of participant in the market, too: the speculator. Speculators simply bet on which way prices are going to go. Although they don’t want to physically possess any of the commodities they’re trading (that is, they don’t really want a truckload of rice in two months), their trading activity is important because it brings liquidity to the market.

Even for the hedgers, many of the contracts traded on the CBOT rarely result in an actual truckload of grain, rice, etc. going to the buyer or seller. In most cases, investors merely buy or sell contracts that offset their existing positions (that is, if they’ve sold contracts for X number of a commodity, they simply buy contracts for the same amount of the commodity -- often at a different price, which is where the opportunity for profit or loss exists).