Commodity Futures Trading Commission (CFTC)

The Commodity Futures Trading Commission (CFTC) regulates FUTURES and OPTIONS markets in the United States, protecting market participants against market manipulation, abusive trading practices, and FRAUD. Created in 1974, the CFTC was a response to growing use and changes in futures and options markets. Traditionally, agricultural commodities dominated futures trading, but beginning in the 1970s, trading expanded to include FINANCIAL INSTRUMENTS, foreign currencies, U.S. government securities, and a variety of new commodity futures contracts. The CFTC’s major activities include contract review, market surveillance, and regulation of futures market participants. A futures contract is an agreement to buy or sell in the future a specific quantity of a commodity at a specified price. Most futures contracts consider that actual delivery of the commodity could take place; however, some futures contracts require cash settlement in lieu of delivery. For example, the NEW YORK MERCANTILE EXCHANGE offers an April contract in gold. Each contract is for 100 troy ounces, which at $300 per ounce represents $30,000 worth of gold. Most futures contracts are liquidated before the delivery date. An option on a commodity futures contract gives the buyer the right to convert the option into a futures contract. Futures and options must be executed through a commodity exchange and almost always through people and firms regulated by the CFTC. The CFTC reviews all proposed futures and options contracts. Before an exchange is permitted to trade a future and option contract in a specific commodity, it must demonstrate that the contract reflects the normal market flow and commercial trading practices in the actual commodity. Normal trading practices are usually found in the “cash” market for a commodity, but if market norms are not well defined, the exchange must show why a contract should be structured as they propose. The CFTC monitors trading in all commodity futures daily and can halt trading or take whatever action deemed necessary to restore order in any futures contract being traded. Trading in specific commodities is often conducted by relatively few individuals. Hedgers take a position in order to reduce the risk of financial loss due to a change in the price of their ASSETS, while speculators hope to profit by correctly anticipating changes in the price of an option or futures contract. In any market where there are relatively few participants, there exists the potential for market manipulation, raising or lowering prices by a few powerful individuals. For example, during the early 1980s, silver prices rose from $5 to over $50 per ounce, only to quickly fall back to the $5 range. Billions of dollars were made and lost in the silver market, and individuals were accused of market manipulation. Companies and individuals who manage customer funds or give trading advice must apply to the National Futures Association, a self-regulating organization approved by the CFTC. The CFTC also requires registrants to disclose market risks and performance information to customers. One of the relatively new roles of the CFTC is to oversee trading in derivatives, contracts whose value is based on the value of the underlying financial asset or security. Derivatives LEVERAGE existing futures contracts, which in turn leverage the commodity they are based on. Leveraging allows buyers and sellers to benefit (or lose) from small changes in market prices while only having to pay a small percentage of the value of the contract being traded.