 As mentioned in the introduction to this lecture, we're going to walk through the specific steps of executing a buy and sell order on the floor of the New York Mercantile Exchange. We're going to be doing this during the regular session where there are active traders in the pits doing what they call the open outcry trading. In order to understand what's going on, there's two key terms here that we're going to need to understand. One is a bid and it's a motion to buy a futures contract at a specified price. The opposite of that is an offer, again a motion to sell a futures contract at a specific price. And that's also known as the asking price. And we use the word motion because the traders are using various hand signals to communicate to one another across the pits if they're buyers or sellers, what fine and what price. So the example we're going to use in this case is a 12 month price, a 12 month strip average of $3.50. As mentioned in lesson seven, you can go out and you can buy or sell contracts at an average price as opposed to having to buy or sell at each individual month's price. In this case, we're looking at 12 months out. So currently this 12 month strip is running $3.50 and there's a producer out there who would like to lock this price in or better if he or she can get that. So the producer is going to call a trader at the energy company and tell them that they're interested. So the trader will turn around then and they will ask the personnel on the fixed price desk to call New York and find out where the market currently is, where the bids and where they offer for this 12 month strip for natural gas. Energy trading companies that have financial derivative trading, they will have a fixed price desk. These are the personnel mostly responsible for dealing with the New York Mercantile Exchange. So the fixed price desk calls their broker on the floor of the New York Mercantile Exchange to find out the current market quotes in both the bid and offers. Now the person that they're talking to is the clearing broker and specifically the phone clerk. If we recall the picture of the floor of the New York Mercantile Exchange from lesson seven, you can picture those phone banks. So this is where that phone call is going to. The fixed price desk person turns around then and gives the trader the current market quote. The producer then gets that bid and offer from the trader and given that the market is still in the $3.50 range, the producer decides that he or she would like to lock in the price of $3.50 or better for the next 12 months if in fact it can be executed. The trader now takes the order from the producer and passes it along to the fixed price desk. Now at this point in time the producer is obligated to perform under this contract. In other words the producer realizes that the energy trading company is going to have to enter into the legally binding contracts on the New York Mercantile Exchange to obtain this fixed price for them. And so the producer is going to have to perform by giving the physical gas when the time comes to the energy trading company. So the trader gives that order, a sell order to the fixed price desk. The fixed price desk then calls New York again, tells the phone clerk with the clearing broker on the floor of the NIMEX that they would like to sell the one month strip $3.50. The phone clerk immediately stamps the ticket that they have indicating when the order was received from the fixed price desk at the energy trading company. The phone clerk will then walk over to the pits and hand a copy of that ticket to their broker who is trading in the pits themselves. That pit broker then offers out the 12 month strip into the market at $3.50. Another broker who has received a buy order from another customer decides to go ahead and lift the offer on the 12 month strip at $3.50. So keep in mind that as we mentioned in the prior lesson it's a zero sum game. For every buyer there is a seller. In this case the producer is having the trading company sell contracts for them. There has to be a buyer across the pit willing to buy those contracts in order for the deal to be consummated. So in this case there happened to be an interested party on their other end and for our purposes we will go ahead and assume that it's an end user who is interested in buying the natural gas at $3.50 for the next 12 months. So once the counterparty across the pit has gone ahead and lifted the order the broker now hands the order back to their phone clerk. And the pit brokers also then have an official form that they have to fill out for the New York Mercantile Exchange which includes the details of the transaction. So the phone clerk now time stamps the ticket as in they've had a time stamped when the order was received and again is stamped with the time when the order is actually filled. So the phone clerk calls the trader's fixed price desk. The trader's fixed price desk receives the fill from the floor of the NYMEX and repeats the fill verbally to ensure that there's no error. So the clearing broker phone clerk and the trading company's fixed price desk repeat the details of the transaction so that there's no mistake as to exactly what has occurred and as mentioned in the prior lesson the phones are also recorded so if there's any dispute at the end of the day when it comes to check out the trades between the energy trading company and the broker they can pull the tapes as we say if there's a discrepancy and have it resolved that way. Okay the fixed price desk now having confirmed the order passes along the fill to the trader. The trader now passes along the completed order to the producer. So the producer has gotten done what the producer wanted. So the producer is now what we call hedged if natural gas prices decline below $3.50 across the next 12 months. So they can't get a price any lower than $3.50. However because of that they give up any upside. In other words the producer cannot get a price higher if the market does move up. But in the situation the producer liked $3.50 and they wanted to make sure that prices didn't fall on them. Here's some more terms that are frequently used in terms of New York Mercatile Exchange trading. We already covered the ask and the bid. A bull a lot of you have already heard this term but it's actually someone. It's a person who anticipates an increase in price or an increase in volatility. Volatility is a measure in the magnitude of price change as well as the frequency of the change in price. And they are the opposite of a bear. A bear again is a person who anticipates a decline in price or volatility and they are the opposite of a bull. Backwardation it's a market situation in which the futures prices are lower in each succeeding delivery. It's also known as an inverted market. It's the opposite of contango. So let's say for instance the September crude oil contract if right now it was the highest price and October was lower than September and November was lower than October and so forth we would have a backward dated market because the normal situation is the prompt month or near month and for several months going out prices do rise. A broker is a party or company which is paid a fee for transactions in the financial and physical markets. Brokers do not take title to the contracts. They do not take title to the commodity being traded. They simply join counterparties together and they extract a fee for doing so. They are truly middlemen. The cash market is the market for a cash commodity where the actual physical product is traded. So we've mentioned a couple of times we differentiate between financial and physical or cash market places when I talked about the pricing publications they cover the cash market. The CFTC that's the Commodity Futures Trading Commission. This is the federal agency responsible for the oversight of all commodities trading not just energy commodities. The contango market this is the opposite of the backward dated market. It's a market situation in which the prices are higher in succeeding delivery months than in the prompt month. To cover we use that term to talk about a trader or company who happens to be short futures or options positions. In other words they've sold contracts in anticipation of prices falling. And so that open position is known as a short position until such time as they buy those contracts back and cover that open position. A derivative. It's a financial instrument derived from a cash market commodity a futures contracts or other financial instrument. The New York Mercantile Exchange contract for natural gas is derived from natural gas itself the commodity and the same applies to the other energy commodities on the NYMEX. The last trading day it's the last day of trading for the prompt month contract. Currently for natural gas is three working days prior to the next counter month. We covered the deadlines for each of these in lesson seven. Long. This is a market position based on owning contracts which must be sold or the delivery of the underlying commodity must be accepted is the opposite of short. So a trader or a company who takes a long position they are buying contracts in anticipation of prices rising and then they will sell those contracts hopefully at a profit. The offer we mentioned already we talked about what an offer is. Open out cry is the name given to the pit trading. On the NYMEX purposes it's a method of public auction for making verbal bids and offers for contracts in the trading pits or trading rings of commodity exchanges. It is you know the totally different and electronic trading platforms. The short this is a market position based on selling contracts which must be bought back or the delivery of the underlying commodity must be made is the opposite of long. So again this is where traders are selling contracts in anticipation of prices falling they'll buy them back and make it a profit. We mentioned earlier the idea that when they are short they'll have to cover those positions by buying the contracts back. Strike price we will get more into this when we talk about options but it's the price at which the underlying futures contract is bought or sold in the event that an option is exercised it's also called an exercise price.