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Futures Contracts: Avoid Delivery of One Million Eggs

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What happens when you let your commodity contracts expire.

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If I buy a single futures contract for ethanol on the Chicago Board of Trade, am I literally buying 29,000 gallons of the stuff?

What about picking up a contract on the Chicago Mercantile Exchange for pork bellies? Do I now actually own 40,000 pounds of bacon?

Yes and no.

You have something I want (lean hogs, feeder cattle, cocoa, or even dried silkworm cocoons, popular on the Japanese exchanges), and I have something you want (the money to pay for it).

I buy the contract, therefore I "control" the goods. However, do I really want 5,000 bushels of soybeans -- which is the size of one soybean contract on the CME -- in my pantry? Or 1,000 barrels (42,000 gallons) of light sweet crude -- the size of one contract on the New York Mercantile Exchange -- in my garage?

Not unless I'm a manufacturer. Or a refiner. Or, in the case of dried silkworm cocoons, in the business of doing whatever it is one does with dried silkworm cocoons. According to estimates, less than 4% of commodities traded are actually delivered, which is what happens when a "paper barrel" of oil becomes a "wet barrel."

Now, let's suppose I accidentally let my molybdenum contract (ten tonnes) purchased on the London Metal Exchange expire. What happens then?

All commodities have specified "delivery points." I could conceivably take delivery of my ten tonnes of molybdenum at storage locations in Baltimore, Rotterdam, or Singapore. Had I bought one rough rice contract and let it expire, according to the CME, I could pick up my 200,000 pounds of the stuff at a specified warehouse "within the boundaries of the Arkansas counties of Craighead, Jackson, Poinsett, Woodruff, Cross, St. Francis, Lonoke, Prairie, Monroe, Jefferson, Arkansas, or DeSha."

If I placed my order through a broker, it would be virtually impossible for me to "accidentally" hold the contract past its "First Notice Day" -- the first day a notice of intent to deliver a commodity can be made by a clearinghouse to a buyer in fulfillment of a given month's futures contract.

Any broker that neglects to notify a client that a contract is coming due probably shouldn't be in the business of handling money for others in the first place. If the broker can't contact their client, they'll generally close out the contract for them on the First Notice Day, as most sane people wouldn't know what to do with 5,000 bushels of soybeans unless they headed up an industrial concern -- or really, really loved edamame.

I checked in with Minyanville's Ryan Krueger -- my go-to guy on all things commodities -- and asked if he knew of any futures contracts that had ever slipped through the cracks without being settled.

"Ideally, the broker will make sure everything goes according to plan," the Prince of Peanut Oil told me. "But I once knew a guy who was trading for himself. He bought six egg contracts, with each contract worth 18,000 cartons of one dozen eggs. That's 1,296,000 total. The guy somehow made the mistake of taking delivery."

And?

"Well, there were 28 or so delivery points throughout the United States and it was (and still is, generally) the seller's option as to where to deliver the eggs," he told me. "The seller will always pick the weakest of the cash markets for delivery, so my friend got his eggs delivered to him somewhere in Georgia, where prices were way below anywhere else. He had to unload almost 1.3 million eggs through a local wholesaler at a 20% loss."

"Must've been a pretty unhappy guy," I ventured.

Ryan laughed.

"Not as unhappy as the guy whose job it was to count how many of them were cracked."

No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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