Back to the Futures

[Janick Beauchamp]

After a trip back from Loronar, whose outcome was still uncertain, Griet and Janick both decided that there had to be another way to get their hands on more futures for both the Magic Circle and the Verdict's portfolio. Said Verdict was, more often than not, "in-port" as opposed to patrolling or otherwise being in space, so it was not uncommon for the two of them to be a good distance away from their station. By far the futures with the highest profitability-to-risk ratio were those on restricted materials, but while Griet repeatedly heard about futures, and that they were highly profitable investments but also equally risky, she had no idea as to how to go around trading futures. Nor did she know about what futures really were, or even how to trade futures, and what made Janick the go-to person onboard the Verdict to broker futures. As they were nested in their bedroom inside the Utapau Alchemy Castle, after a hard day alchemizing.

"I would like to learn about futures trading so that I can pull my weight both onboard the ship and among the Circle. I have heard the term futures floated around the Verdict each and every time I have a discussion with the senior crew about the ship's budget and investments portfolio, along with the purser, the bridge crew and you" Griet stated.

"What can I do for you, Griet? Do you want to learn more about futures?"

 

[Janick Beauchamp]

"Tell me everything I need to know: if something was to happen to you, I still have to assume your duties as the carrier air wing commander of the Verdict"

"What does my scope of duty have to do with trading futures? Do you think a CVW commander hold that much responsibility over the ship's investment portfolio? Which faction(s) do you think spread financial responsibility to the pilots onboard?" Janick asked, clearly flustered.

"Who do you think even knows how to trade futures onboard? You trade the futures component of the Verdict's portfolio because you're the only one that can do so with any competence"

To the extent she had to acknowledge that having a contingency plan was a good idea, especially in a carrier air group (which, in ORC naval parlance, was simply the set of fighters onboard a given capital ship, even if the ship is not officially considered a carrier) Griet found that the conversation turned sour very quickly, but, since she knew she was the only person she trusted for trading that sort of instruments, she had to find a way to calm Janick down. Griet knew as well as anyone else that, however easy the aircrew is to recruit for in the ORC, losing pilots was a reality of the field. Whereas stocks, bonds and deposit certificates were often the order of the day in most portfolio management techniques, and much more easily understood than futures were, hence their bases being covered, was there really no one else among the 109,000 crewmembers of the Verdict that actually knew that stuff, other than perhaps the purser? Or did financial literacy among naval crewmembers often stop at managing a budget?

 

[Janick Beauchamp]

"Don't expect the same spread of skillsets among the general population vs. a capital ship crew. However, since you showed willingness to learn about futures contracts, or futures for short..."

"Why are you so fixated on trading restricted materials futures?"

"The difference between RM futures and non-RM futures is that RM futures, while equally risky compared to non-RM futures, can carry much larger margins of profits since people willing to fulfill the delivery conditions of futures at a premium, even in today's more relaxed marketplace"

Griet knew that, among the 22 materials commonly understood as restricted, not all of them could even be tradeable. That, even though every alchemist worth their workshops knew what they were. Sometimes they were tradeable by other means, but not on a futures market. The fifteen Schedule 1 materials were all tradeable on commodities markets provided one of the eight standard conditions could be met. Schedule 2 materials were more trade-restricted, and these were AI, impervium and stygium. Schedule 3 materials were, well, not tradeable on commodities markets: orbalisks, alchemy, void stones and Force-nexi. So alchemy was itself a RM but cannot be traded as a raw material, as a commodity in itself, and only the finished products? Griet thought, while curious as to exactly what a futures contract was and what were common terms one could find on futures, regardless of whether or not their underlying assets were RMs.

 

[Janick Beauchamp]

"A futures contract is a standardized, legal agreement to buy or sell something, called the underlying asset, at a pre-determined price at a future date. The underlying asset is usually a commodity or a financial instrument"

"What makes RM futures so profitable? You said that today's market for RM futures was more relaxed than past markets, how?"

"In the past, songsteel futures had two possible delivery conditions: either the buyer had to fight a duel whose report had to have at least half its lines rhyme or the buyer had to sing a battle song for their allies in an invasion or a rebellion. I know it because it's a big component of the Circle's investment portfolio"

Under the old trading floor systems, some conditions could get wacky if one wanted specific RMs on a futures market: completing a report on an activity from a first person perspective while only using "I, me, my" a total of six times for neuranium, suffering devastating defeats at the hands of a FU, Mando, NFU for cortosis, beskar and phrik respectively. Or even completing a report without using the word "the" on another activity being an old delivery condition for void stones until the practice ceased. And that was before alchemy was declared a RM, or even Echani graphite or Hijarna stones. But Griet still struggled with how delivery conditions affected a RM futures' profitability, and where the risks came from. Maybe Janick will clear up that issue later, yet, for the time being, she had only the most basic ideas on futures, what they are, and nothing as to what's important to watch out for when trying to buy or sell futures. Of course, she would be reluctant to trade RMs if the buyer struggled to meet the delivery condition, making the futures a pointless investment.

 

[Janick Beauchamp]

"Jane, what are common terms that can be found on futures?"

"There are basically five terms: the underlying asset, how much of it (the contract size), the maturity date (the same as delivery if a commodity), the delivery or settlement procedure and the price"

"It goes without saying that the larger the size, the higher the price. What else should I know about contract size?"

"For RMs? Report length: the longer the report, the greater the size tends to be"

In the world of RM futures, there are three commonly accepted contract sizes for industrial use: unique, semi-unique and limited. Futures with unrestricted materials as underlying assets tend to be more specific as for contract size. But it puzzled Griet: how legally enforceable is something as vague as a limited-sized contract? Or what's the legal meaning of semi-unique? Did Janick imply that a lump sum of money was paid for the futures regardless of actual tonnage? Often unrestricted materials futures were priced per ton of the material. Also, what else other than commodities could be traded for using futures? Did Janick trade something other than commodities when trading futures? Griet thought, while there still were several questions unanswered about futures and exactly how someone would go around trading them. The blonde pilot wondered just what caused the crew trust Janick for trading futures to the extent they do, and these parasitic thoughts might make her uncomfortable actually attempting to buy futures without additional information.

 

[Janick Beauchamp]

"What else can be traded through futures, other than commodities?"

"Non-RM, and certainly non-commodity futures must constantly be watched for price fluctuations and, with it, whether they are in or out of the money. Stock markets, interest rates are the main non-commodity items"

"What makes an investment in the money or out of the money?"

"In RM trading, the moneyness of a futures is nearly completely dependent on the fulfillment of its delivery condition if the contract is larger than unique. The best you can hope for if the delivery condition is not met is to be at the money, that is, break even: a RM futures whose delivery condition is not met is usually worth its margin, at most a little more than the margin"

Margin? What does Jane mean by margin in the context of futures trading? What is the margin used for? Griet thought, while her seemingly unstoppable train of thoughts generated more and more questions in her brain before she could actually consider that her understanding of how futures trading actually operated was sufficient to be comfortable trading futures, regardless of whether or not they were for RMs or not. A Jedi uses the Force for knowledge and defense, not for aggression or personal gain... but this knowledge is clearly usable for personal gain! Was using it for a collective investment portfolio the same as personal gain? she thought, after the train of thought moved in another direction, and being reminded of her Jedi training back as a Republican pilot. Quickly she began shaking her head while Janick spoke of the value of a RM futures relative to its margin. Clearly they were entering arcane territory and they were going where no Jedi would dare go.

 

[Janick Beauchamp]

"Something's not right, Janick"

"Enchantress Actual, what's wrong?"

"I've been trained as a Jedi and they told us to use the Force for knowledge and defense, and not for aggression or personal gain. I get that Jedi usually overlook the financial, but it's making me uncomfortable"

And attachments lead to the dark side, but also from it. My master was a pretty orthodox Jedi, but already being away from the formal structure of the Jedi Order wastaking me in a direction that I never suspected I would be taking. The big pieces in the Magic Circle's portfolio are their shares in the Asop alcohol drilling fields, as well as the songsteel futures, Griet thought, while Janick was seemingly unaffected by her executive officer's growing discomfort around the topic. What made Griet so comfortable talking about KITAs, motivators and hygiene factors as applied to a starfighter corps, or said corps' ledgers, but not futures and how they worked? Janick thought, in turn, while puzzled by how suddenly Griet started talking about the Jedi Code and its implications, while she wanted to know more about futures. Even then, Janick stayed for a while in a Jedi Temple, but she only vaguely heard about the Jedi Code beyond the Code proper.

 

[Janick Beauchamp]

"Back to the topic of margins. In the context of futures trading, margining is done to minimize credit risks, and also to cover the day-to-day demands of maintaining one's position. Typically, in a non-RM futures, it's about 5-15%, but 70-100% aren't uncommon in RM futures; the larger the futures, the lower the margin"

"I knew that RM futures were quite different from conventional futures, and in many ways rather than one. However, who usually deals in futures trading?"

"Futures traders tend to fall into two camps. There are hedgers who, in a commodity context, usually do so in an attempt to secure their supply of commodities against price fluctuations and it was originally applied to agricultural products. And there are speculators, who are in it mostly for the profits"

Futures first came about at a time where out-of-season produce and in-season produce mattered, such as on primitive planets. So hedgers, as Griet understood them, were those who were interested in the underlying asset's delivery, and speculators seldom had an interest in the underlying asset's delivery. So which one Janick was? She seemed to be a speculator more so than a hedger, but I guess, it depends on her portfolio. Supply and demand for RMs was highly variable, and I suppose that most of the demand for RMs was for low-level stuff, at unique level. From my experience, most RM demand was for personal equipment, sometimes at considerable expense for the buyers, Griet thought, while pondering where Janick fit in among the financial food chain. She definitely had a better idea as to how stocks and bonds were traded, and trusted whoever traded those things onboard the Verdict, usually someone close to the purser. Just that futures seemed to be so complicated to Griet...

 

[Janick Beauchamp]

"Which one are you, a hedger or a speculator?"

"Mostly a speculator, for stuff outside the RM markets, but in the RM markets, I'm a high-volume hedger"

"Anything else I need to know about futures before I get to the more hands-on stuff?"

"Options. Sometimes you have a transaction that say, I will buy (or sell) X amount of an underlying asset in futures, with an option for Y more, with a purchase option called a put and a sale option called a call. In both cases, the strike price is the price of the option at the time of exercise"

In a RM context, options are usually contingent on lengthening a report until it reaches a specified length. Today, however, there seems to be a stigma attached to high-volume RM trading, precisely because hedgers tended to abhor the report-writing exercises that the delivery phase usually entailed. In all other contexts, the seller is perceived as taking on more risk because it is contractually obligated to take the opposite position should the buyer exert the purchase option. So Griet was edging closer to the good stuff, to what she wanted to learn out of the futures trading process, while realizing that a high volume of futures tied to the same underlying asset would lead to minute fluctuations of the asset's price generating correspondingly high gains or losses. Is it worth it to take out a loan for investments? Or banks will refuse to lend me the money just because the investment is too risky? Griet thought, while her brain worked hard to absorb the knowledge.

 

[Janick Beauchamp]

"If speculators sell off their futures long before they mature, then why is the delivery date relevant?"

"They are relevant to hedgers, because they usually use the resources in the contract. As you said, speculators close their positions long before the stuff is actually delivered"

"What does opening and closure of positions mean?"

"A buyer is usually in a long position, a seller in a short position. The position entered by the initial transaction remains open until an opposite transaction takes place, which then closes the position"

So exactly what would Janick hope to achieve by flooding me with arcane finance terms? Is that necessary to actually learn what I asked from her, from my commanding officer? When will we get to the more practical aspect? Griet thought, while the feeling of frustration begins to mount. It became clear what these two ladies' relationship with money were: one knew better how to budget, the other how to raise money with an investment portfolio. These were the reasons why they could even be in this position in the first place, like no Jedi would otherwise hope to do. Either the bush to beat around is very large and the learning curve was steep, or there was an ulterior motive pursued by Janick. Does Jane want me to run a separate portfolio for the carrier air wing of the Verdict at some point? I'm not sure how would that be beneficial: having one ship-wide portfolio gives us a better leverage over several portfolios, she thought.

 

[Janick Beauchamp]

"I begin to suspect that you may want to split the ship's portfolio in several components, at least one for the carrier air wing, yet a larger portfolio gives us more leverage to buy securities of all kinds on markets than many smaller portfolios"

"That leverage can be a liability especially if we get too big. We can cause prices to go up or down with transactions"

"But a portfolio made up of the savings of 109,000 people is not large enough to cause the prices to go up or down with transactions we make at a level higher than a planet, and even then one would have to think of a planet like Jelucan"

"And our operating budget, remember?"

Battlecruisers' upkeep is, simply put, expensive. 109,000 crewmembers have to be paid and catered for in the form of consumables, the ordnance for so many systems, as well as the fuel, both for the mothership and the fighters. That's why even large factions only field a handful of them. The Silver Jedi had about 10 in service, the GA had 16, the Sith Empire had at least 6, the First Order had at least 15, and even then the complement can be troublesome, especially for the First Order and the Sith Empire. For informational purposes, the First Order had 129,000 crew members on each of their five Darr Itahs, and 74,000 on each of the remaining Resurgents. But the Verdict was the battlecruiser that required the most upkeep among the ORC's fleet of battlecruisers. It was a staggering amount of money that had to be handled by the ship's purser, hence the need for several crewmembers to handle the ship's money reserves and investment portfolio, which is staggering.

 

[Janick Beauchamp]

"Do you mean that the ship lives off of its investment portfolio? How much of the portfolio is held in futures?"

"The more profitable the investment portfolio, the less funding it needs from the central Coalition government. The futures part of the portfolio is worth roughly 5 billion credits, with that representing roughly a quarter of the total portfolio, of which 5% is spent yearly or all the upkeep cost is accounted for, whichever happens first"

"Which means that the ship doesn't live off of its investment portfolio unfortunately"

Long story short, 1 billion credits a year is not enough to keep the ship running, especially not with 109,000 crewmembers. Griet came to a grim realization: investment portfolios needed to yield at least 5% year-on-year to be worth it to the crew or, in the long run, the portfolio will run out of cash, too. But, if there were shrewd investments to make, perhaps one day the carrier air wing will live off its futures portfolio - and then some. But surely it wouldn't cost 250 million to run 5 squadrons and its ordnance for a year. Not in Griet's mind. The Verdict's carrier air wing can live off of the ship's futures portfolio. But the purser will never approve of the carrier air wing running off the futures portfolio, no more than banks would allow us to borrow cash for investment purposes, she thought, while pondering what the financial implications for the rest of the ship were, and realizing that banks would not extend loans to a military for the purpose of investment in securities, much less when there is no collateral.

 

[Janick Beauchamp]

"When are we going to actually cover the how-to of trading futures?" Griet screamed in her exasperation.

"I understand your frustration, and I couldn't help but feel the Are-we-there-yet on your part. What worked for me is electronic trading, and I highly recommend it to anybody that wishes to try their hands at futures trading"

"OK?"

"The actual process begins when you send buy or sell orders. Usually on brokerage sites you have your own profile with your own banking information ready. Just be mindful of your bank account balance"

"I know, I know"

Machinally, Griet starts entering the banking information from one of Utai Magic Circle's bank accounts that is usually used for drill bits while opening her own profile on the very brokerage site that Janick used to carry out her financial bidding. So the Magic Circle was using five bank accounts here: one for the alcohol, one for the drill bits, one for the spacecraft components, one for the investments and the last one for the customized stuff. I guess, I'm taking an accounting risk by using the drill bit account as my source of money to invest in futures. But no, I'm not embezzling money! she thought, while Janick guided her through the process, with the understanding that whatever restricted material she was to buy using futures would not be sufficient with the drill bit account alone for what Janick had in mind. She had no choice but to put as many eggs into the restricted material basket when Griet was opening her position on the RM futures market.

 

[Janick Beauchamp]

As she was busy setting up her futures trading account, on the datapad, using the broker Utai Magic Circle is using, and also setting up the order, Griet looks askance at the screen from the brokerage interface, which, prior to the order being actually placed, they asked for confirmation. Understandably, placing orders for buying - or selling - futures was an act with serious financial consequences for the unprepared, so asking for confirmation was a good idea. Grateful she is for that feature, but more advanced futures traders, like Janick, have become annoyed after a while. On the confirmation screen, there are two pieces of information that seemed related to what she learned beforehand but whose relationship to terms she previously learned was not immediately obvious to the blonde pilot. Initial margin and maintenance margin. Before she could confirm the purchase of the laminanium futures, she had to make sure she understood what those margins were, to ensure that she is not making a big financial mistake that may well wipe out her portfolio.

"What the feth? Initial margin is higher than the maintenance margin? What are the differences between those?"

"What I called margins earlier refers only to the initial margins. It's a security deposit, while the maintenance margin is the minimum balance one needs to maintain in the trading account to cover losses. You will learn that one of the big nightmares of a futures trader is the margin call"

 

[Janick Beauchamp]

"Margin call? What makes a margin call a scary prospect?"

"A margin call occurs when you fail to meet the maintenance margin and hence the sign that you're losing money, in which case the broker will call you to put more money until you meet the initial margin, or else that component of the portfolio will be liquidated and your position on that component will be closed. That amount is usually known as the variation margin. In addition, it seems that you skipped a step or two in the process of trading futures"

"What do you mean, I skipped a step or two?"

For example, suppose that a trader bought some futures on, say, duranium, at 16% initial margin. A week or so after the position opening, huge losses have been posted for the duranium pricing, causing the duranium-backed futures to lose so much money that the losses incurred go below the maintenance margin of 13%. In that case, the investor would need to add money into the account not for the difference between the current balance and the maintenance margin, but the initial margin. That is part of what makes high-volume trading of futures a risky tool for any portfolio manager. Thank the Force for the confirmation screen! I don't think I'm ready to confirm the buying order just yet, she thought, even though she knew that the more experienced Janick has bought her component of the laminanium in the portfolio, as required for the transaction, for what she had in mind. Of course, because Janick has 5 billion credits at her disposal, she has a much greater leverage to buy RMs than Griet did, only having a few million in the Magic Circle's drill bit account.

 

[Janick Beauchamp]

"What's your outlook on the underlying asset?"

"Laminanium is the best fit given what we want to use it for. Usually RMs tend to have better outlooks if there's a short-term market for a specific product"

"Second, risk tolerance. How much of the portfolio do you want in that particular RM?"

"I practically broke the drill bit bank account, and leaving only the minimum daily balance on it just to get that trade done, so it shows you I'm willing to risk almost all of it"

A reckless trade that is. But Griet had so much faith in that investment that she is willing to pull as much weight as she could on it, and, if the profitability-to-risk ratio was to be believed, she stood to make the Magic Circle go big. But it was a little abusive to talk about it in those terms, since it was just a code for the coefficient of variation. Perhaps that was because the expected profits were so low but the range so wide that Janick described restricted materials futures as an investment with high profitability to risk ratios, Griet thought, while the risk of losing money can be pretty high, with some probability of turning in a small profit, and a tiny probability of striking it rich. So Janick was also undergoing the process of buying as many laminanium futures as she could from other people, while at the same time closing her position on many more futures in order to raise the necessary money while Griet was struggling to understand exactly what the steps are.

 

[Janick Beauchamp]

"There's also, on the confirmation screen, a line about the limits on a type of futures. What are those?"

"There are three types of price limits, which are the amounts by which a given type of futures can move in a standard day. A limit move is triggered when a transaction would occur at a higher/lower price than a given limit, an upper limit or lower is a maximum daily movement up or down respectively, and a bilateral limit. Triggering limit moves is called locking the limit. When a limit is locked, transactions cease for either the day or until the market, that is, the spot price, is going lower than an upper lmit (higher than a lower limit)"

A more thorough reading of the confirmation screen was only raising more questions in Griet's mind, all of which she knew needed answers before she could actually go forward with the transaction, much less managing the Verdict's and the Circle's futures portfolios. She knew that, once an order is placed, it's processed, and the transaction is considered done. I would readily understand now, if lower limits were more common than upper limits, because it prevents investors from losing money too quickly. But upper limits and, with them, bilateral limits? I would hazard a guess that upper limits is to prevent another nasty thing, she thought, while not being exactly sure of what exactly is that nasty thing that occurs when the prices spiral upward out of control: perhaps that has to do with the consumption of the underlying asset if a commodity. Spiraling downward out of control can be dangerous to a speculator, too, even though it's beneficial for other stakeholders in the process, if it's a commodity of some sort.

 

[Janick Beauchamp]

"Exactly how does one gain money in such an investment?"

"If you hold on to a futures on a daily basis, supply and demand will make it so that the price fluctuates, and, at the end of the day, the price of your portfolio is getting adjusted"

"Hold on, Jane, you're telling me that commodities futures are the equivalent of stocks but for commodities?"

"Not exactly. Stocks usually don't have expiry dates attached to them; usually commodities futures on perishable commodities have the shortest delivery dates. As for RMs, usually the prices for a given RM spike when a product is announced using that particular RM"

The process for adjusting the portfolio's valuation at the end of a trading day is called marking to market. Suppose Griet would actually go through with the transaction. A price is then set and money is deposited into the account at that point. At the end of the day, the clearinghouse determines a price and then adjusts the account accordingly, up or down, based on the difference of the price. And, of course, the following day's opening price is the same as the closure price of the previous day, Griet thought, while Janick was able to free up 3 billion to buy what laminanium futures she could in a very short span of time. The process was not yet over but since there were so many different types of futures in the ship's and the Circle's respective portfolios, until now, Janick felt confident that, even if there were some losses across parts of the portfolio, on the whole any losses, and gains, would be limited, by closing so many positions on so many different types of futures.

 

[Janick Beauchamp]

"I think I know enough about futures to be confident about the transaction, to be investing all 5 million in the drill bit account in laminanium futures"

"Don't forget: when the order is placed, the brokerage's computer systems process orders in a first in, first our manner. Once you have determined how much to buy or sell, of which type, the transaction proper can be made. Don't be shy..."

Usually it goes that way, when it comes to trading RM futures: Company A or, less commonly, Workshop B, announces the development of a given product using a given RM, then the prices on the futures markets for that RM and the prices peak when the product in question finally hits the marketplace. Now that I understand what futures are about, and how to go around trading them, I can finally rest easy and understand exactly what drives markets; it's in the bag, Griet thought, before finally pressing the button confirming the transaction, the purchase of those laminanium futures. She also realizes that, as with any securities brokers, futures brokers usually ask for commissions for each order to be processed, but also that the commissions go on a sliding scale: while a larger trade would cost more in absolute terms, in relative terms, larger trades cost less. And then she patiently watches Janick as she finalizes the process of opening her positions on more futures to raise the necessary materials.

 

[Janick Beauchamp]

"Griet, may the Force be with us and may you manage the futures portfolio of the Circle responsibly"

"I think I can pull my weight provided you give me the time to actually understand the markets for other futures, on the commodity or financial markets"

Griet was so happy that it was over. Yes, in a RM context, Janick made it sound as if they were traded more like people would trade stocks, if only stocks with an expiry date. But the blonde pilot realized exactly why it was only once in a blue moon that someone could ever hope to hit it rich trading restricted materials futures. Plus, after compiling the value of the remaining futures in the ship's portfolio, she arrived at the conclusion that the futures portfolio still comprised 2.3 million in value not tied to that laminanium. Both Janick and I are riding our own duties as portfolio managers and probably even our positions at the head of the carrier air group if we screw up this investment: then again, it's usually factions like the First Order that fuss more about how the crew manages the funds onboard. The Republicans never let the Jedi anywhere near the starfighter corps' money, no matter how many squadrons they had under their command, Griet thought, while monitoring the price of the very material she blew nearly all the Circle's drill bit money using futures for it.