Hey Buddy! Where do you want your soybeans?

Can someone really dump a futures contract's worth of soybeans on your driveway?

The futures markets have their roots in physical commodities: corn, rice, wheat, livestock, precious metals, petroleum, cotton, coffee, sugar, potatoes, lumber, even U.S. Treasury bonds and Japanese yen. Tangible stuff. 

Today, the majority of contracts traded are based on financial instruments and they are cash settled. That means when the contract expires and the holder wants to take delivery they get cash, not stuff. 

Cash settlement was developed as a way to satisfy the delivery requirements of the Chicago Mercantile Exchange’s Three-month Eurodollar futures. The Eurodollar contract is based on the three-month London Interbank Offered Rate (LIBOR). There’s no such thing as a physical LIBOR interest rate bill. So the exchange hit upon the idea of having contract delivered in the cash value of this interest rate product. 

The cash settlement mechanism has been used for stock index, weather, feeder cattle and propane futures. Old-school traders (folks who were on the trading floors in the 1990s and before) complained to me that the cash settlement tool is convenient, but creates detachment between the pits and the underlying commodities. 

When the futures markets were originally created each contract was backed by the promise to deliver physical goods. A futures contract seller assumes the obligation to deliver at a fixed time, a specified amount of the commodity which meets a certain specification at a pre-determined location. The buyer takes on the obligation to pay for the goods in full and take possession at the same location. The contract became a valuable pricing tool market participants used to value related commodities or product not at the delivery point.

Buying a futures contract was one way to acquire product in an open and accessible market. Few contracts are held to delivery. Most traders use the futures as a hedge and as contracts reach their expiration the positions are rolled forward to the next contract or are closed out.

The point is even though the pits were far from farms, oil wells or mines, there was a strong connection through the delivery mechanism. Lest traders at the Kansas City Board of Trade forget the exchange’s roots, bowls of various grades of wheat sat on a shelf on the trading floor to remind them about the product they were trading.

My father didn’t know that when he found out that my Uncle Julian bought a Chicago Board of Trade (CBOT) soybean futures contract on his behalf. It was the 1960s and Uncle Julian, who was always looking for investment opportunities, saw that soybean prices were hot.

Julian always was willing to talk with me about the markets and he frequently shared his investing tips. He thought he had a good thing with soybeans. So, he bought a couple of contracts, made some money, sold the position and called my Dad. 

I think the conversation went something like this (I was only four-years old at the time):

RING, RING, RING!!!

Uncle Julian: “Hey Otha. (My dad’s name was Otha Webb Linton.) If you send me a check for $500, I’ll send you a check for $1,000.”

Dad (Otha): Hey Julian, How are you? That sounds great. When do you need the check?”

Uncle Julian: “As soon as I get the money, you get yours.”

Dad: “The check is in the mail.”

Uncle Julian: “So, we could do this again. This time, it might be a good idea to send me money today and I’ll invest it for you.”

Dad: “Uh, what?”

Julian: “Yeah I’m buying soybean futures and we can share the profits. Just send me a check for another $500 and we can invest it in the market.”

Dad: “Julian!!! Are you out of your cotton-picking mind?” (Dad was from Western Kentucky and this was one of his favorite expressions.)

Pause.

Dad: “I don’t want to be involved in trading soybeans! How about those Bears?”

As he later recounted to me, my Dad said he worried that if for some reason he couldn’t get out of the market he feared a dump truck showing up to the house with a driver knocking on the door asking “Where do you want your beans delivered?”

Dad was a PR man for the American College of Radiology in Chicago. He knew nothing about trading futures. His fear was reasonable but overblown. The concern about being delivered against was valid. Had he held the contract to delivery, truckloads of soybeans would not unexpectedly show up at the house. Instead he would have received a notice of delivery from the exchange. It would have told him that the beans were being held for him at a grain elevator on Chicago’s south side. He would owe the full amount for the beans. (Remember that a futures contract is a leveraged transaction. You only put up a small fraction of the cost to control the entire volume of product.) Then he’d start paying storage fees while figuring out what to do with them. 

That never happened.

The next installment of this blog will discuss some of the shennigans that can occur as contracts expire and the consequences of taking delivery of a CBOT silver contract.

Note to readers: Going forward, Tales of Yore from the Trading Floor will be published monthly.

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This blog is about more than my experiences. It is intended to be a collective experience of working on the commodity markets physical trading floor. If you or someone you know has a story please let me know I’d like to include it in this ongoing chronicle. I can be reached at linton122@gmail.com

© Clifton Linton 2023