Passing the Series 3

A complete textbook for the National Commodity Futures Examination

Preface

This book teaches everything tested on the NFA Series 3 exam — the National Commodity Futures Examination — and nothing that isn't. It is written for the candidate who intends to register as a Commodity Trading Advisor, Introducing Broker, Associated Person, or Commodity Pool Operator, and who wants to sit the exam once.

The Series 3 is not a hard exam. It is a wide one. It asks 120 questions across futures theory, contract mechanics, hedging arithmetic, speculation, spreads, options on futures, and a dense block of federal regulation — and it is scored in a way that punishes uneven preparation. Most failures are not conceptual. They are candidates who knew the markets cold, skimmed the regulations, and lost on a technicality of the scoring rule.

The organizing principle of this book is the exam blueprint. Every chapter is sized to what the topic is actually worth. You will see the weight in the sidebar and again under each chapter title, so you always know whether you are studying a 19-question topic or a 3-question topic.

The exam, precisely

The scoring rule that fails people

You must score 70% on Part 1 and Part 2 separately. There is no combined score, and there is no compensation between the parts. A candidate who scores 95% on Market Knowledge and 65% on Regulations fails the entire exam and retakes the whole thing.

Part 2 is 35 questions. 70% of 35 means you may miss ten. Eleven misses on the regulations alone ends the attempt regardless of how well you traded the rest.

Regulations are 29% of the exam — the single largest block, larger than hedging, larger than speculating, larger than options. They are also the part candidates most often treat as an afterthought because the material is dry. Chapters 14–17 exist to prevent that.

Blueprint — what each topic is worth

Two observations that should shape how you study. First, hedging and basis (19 questions) is the largest Part 1 topic — larger than options and spreads combined, by a factor of two and a half. Basis arithmetic alone is worth more than every option question on the exam. Second, spreading is 3 questions. It is interesting material and it is nearly worthless to your score. Chapter 10 is deliberately short. Do not spend a week there.

How to use this book

• Read in order. Chapters 1–2 build the vocabulary every later chapter assumes. The exam tests terminology directly (16 questions) and uses it as the language of every other question.
• Work every worked example by hand before reading the answer. The exam's arithmetic is simple but relentless: contract sizes, tick values, basis changes, breakevens. Errors come from haste, not difficulty.
• Do the practice questions at the end of each chapter. Answers are click-to-reveal. Try first.
• Use Quick 10 for daily reps. Ten questions, instant feedback, no clock — the format that fits in a spare five minutes. It remembers every answer, so it serves questions you have seen least and you work through the bank instead of recycling the same forty. It also tracks lifetime accuracy by topic, unlocks a weak-topic drill once a topic has three answers, and keeps a review pool of questions you missed that empties as you get them right.
• Then use the rest of the study app. 204 flashcards, a Learn mode for adaptive mastery, per-chapter quizzes, and a full timed mock exam drawn from the 510-question bank. Part 1 is sampled stratified to the blueprint above — 16 theory/terminology, 15 margin/settlement, 11 orders/analysis, 19 hedging/basis, 16 speculating, 3 spreading, 5 options — so the mock's topic mix matches the real exam rather than whatever the bank happens to hold. Both parts are scored separately against the 70%-each rule. Two attempts share under a quarter of their questions. That mock exam is the single most useful thing in this package — take it under real conditions before you sit the real one.
• Appendix A is the formula sheet. Appendix B is the exam-day playbook. Appendix C is the glossary — the terms most likely to appear as a direct definition question.

A realistic schedule

At 8–10 hours per week, this book is a five to six week program:

Run a Quick 10 every day alongside whatever chapter you are on. Ten questions takes three minutes, and the topic accuracy it accumulates is what tells you where week 6 should go.

Do not schedule the exam until you are passing full mock exams at 80% on each part. The margin between 70% and 80% is the margin for exam-day nerves and a bad question set.

Table of Contents

Part I — Foundations (16 questions · 13%)

• Ch. 1 — The Futures Market: What It Is and Why It Exists
• Ch. 2 — The Language of the Contract

Part II — Mechanics (15 questions · 13%)

• Ch. 3 — Margin and Marking to Market
• Ch. 4 — Price Limits, Settlement, Delivery, Exercise and Assignment

Part III — Orders, Accounts and Analysis (11 questions · 9%)

• Ch. 5 — Order Types and Customer Accounts
• Ch. 6 — Price Analysis: Fundamental and Technical

Part IV — Hedging (19 questions · 16% — the largest Part 1 topic)

• Ch. 7 — The Hedge: Long, Short, and Why It Works
• Ch. 8 — Basis: The Number the Exam Loves

Part V — Speculating (16 questions · 13%)

• Ch. 9 — Speculating: Leverage, P&L and Risk

Part VI — Spreading (3 questions · 3%)

• Ch. 10 — Spreads

Part VII — Options on Futures (5 questions · 4%)

• Ch. 11 — Options on Futures: Fundamentals
• Ch. 12 — Option Strategies: Hedging, Speculating, Spreading

Part VIII — The Financial Contracts

• Ch. 13 — Interest Rate, Stock Index and Currency Futures

Part IX — Regulations (35 questions · 29% — Exam Part 2)

• Ch. 14 — Regulatory Structure, the CEA, the CFTC, the NFA and Registration
• Ch. 15 — Customer Accounts, Disclosure and Required Documents
• Ch. 16 — Sales Practices, Prohibited Conduct and Promotional Material
• Ch. 17 — CPOs, CTAs, Recordkeeping, Position Limits and Dispute Resolution

Appendices

• A — The Formula Sheet — every calculation the exam can ask, on one page
• B — The Exam-Day Playbook — timing, the 70%-each rule, and how to guess
• C — Glossary — the definitions most likely to be asked directly

A note on scope. This book prepares you for an examination. It is not legal advice, and passing the Series 3 is one requirement among several — registration also requires Forms 7-R and 8-R, NFA membership, fingerprinting and a fitness review. Verify all current requirements, fees and rule citations directly with the NFA and the CFTC before relying on them; rules change, and the exam is periodically revised to match.

Chapter 1 — The Futures Market: What It Is and Why It Exists

Everything on this exam rests on one sentence, so learn it exactly:

A futures contract is a standardized, legally binding agreement, made on an exchange, to buy or sell a specific quantity and grade of a commodity or financial instrument at a price agreed today, with delivery or cash settlement at a specified date in the future.

Five words in that sentence are doing work, and the exam tests each of them.

Standardized. Everything except the price is fixed by the exchange: the quantity, the grade or quality, the delivery months, the delivery locations, the minimum price increment. Buyers and sellers negotiate only price. This is what makes contracts interchangeable, and interchangeable contracts are what make a liquid market possible.

Legally binding. A futures contract is an obligation, not a choice. This distinguishes it from an option, which conveys a right. Both the buyer and the seller of a futures contract are obligated. Remember it this way: futures obligate both sides; options obligate only the seller.

On an exchange. A privately negotiated agreement between two parties to transact later is a forward contract, not a futures contract. Forwards are customized, traded off-exchange, not guaranteed by a clearinghouse, and carry the credit risk of the counterparty. Futures are standardized, exchange-traded, cleared and guaranteed.

Price agreed today. The price is set at the moment of the trade. What happens afterward is settled through the margin account, daily, in cash — the subject of Chapter 3.

Future delivery or cash settlement. Some contracts settle by physical delivery of the commodity; others settle in cash against a final index value. Stock index futures cannot be delivered — there is no way to hand over the S&P 500 — so they settle in cash.

1.1 Forwards versus futures

This comparison is a reliable exam question. Know the whole table.

1.2 What the market is for

The exam expects three economic functions, in this vocabulary.

Price discovery. Open competition among many buyers and sellers, all acting on their own information about supply and demand, produces a public, continuously updated consensus price for a commodity at a future date. A farmer in Iowa, a miller in Kansas and a bank in Chicago all read the same number. No individual sets it; the market discovers it.

Risk transfer, or hedging. A futures market lets someone who has price risk pass it to someone who wants it. The grain elevator that owns wheat is exposed to falling prices. The baker who will buy flour is exposed to rising prices. Futures let each of them lock in a price now and stop worrying about the direction of the market. The risk does not vanish — it is transferred, most often to a speculator who accepts it in exchange for the chance of profit.

Liquidity. Speculators, who have no commercial interest in the commodity at all, provide the constant flow of bids and offers that lets hedgers enter and exit at a fair price whenever they need to. A market of hedgers alone would be thin, wide and unusable.

The exam's framing of speculators. Expect a question that essentially asks "what is the role of the speculator?" The correct answer always credits them with assuming risk that hedgers wish to shed and providing liquidity and depth. Never choose the answer that describes speculators as destabilizing or unnecessary.

1.3 Who is in the market

And the intermediaries, all of which are registration categories tested in Chapter 14:

The distinction between the FCM and the IB — who may hold customer money — is asked directly and often. The IB may not.

1.4 The clearinghouse: the reason futures work

When you buy a December contract and someone else sells it, you do not end up owing each other anything. The clearinghouse interposes itself between you: it becomes the buyer to every seller and the seller to every buyer. This substitution is called novation.

Three consequences the exam wants:

1. Counterparty credit risk is eliminated. You never need to evaluate whether the person on the other side of your trade can pay. Your counterparty is the clearinghouse.
2. Positions can be offset freely. Because everyone faces the same counterparty, you close a position simply by taking the opposite one. You do not need to find the original trader.
3. Performance is guaranteed by margin. The guarantee is funded by requiring both sides to post margin and settle gains and losses in cash every day. The clearinghouse never carries an unpaid loss overnight.

Clearing members — not individual customers — face the clearinghouse directly. Customers face their FCM; the FCM faces the clearinghouse.

1.5 Long, short and offset

Long means you have bought and are obligated to take delivery. You profit when prices rise.

Short means you have sold and are obligated to make delivery. You profit when prices fall.

Notice what is unusual here. In futures you may sell first and buy later with no borrowing, no locate, no uptick rule and no restriction. Selling short is exactly as ordinary as buying. This symmetry is a favorite exam point.

Offset is how nearly everyone exits. A long who sells one contract of the same commodity and month is flat. A short who buys one is flat. Roughly 97–99% of futures contracts are offset before delivery; only a small fraction go to delivery. If a question asks what proportion of contracts result in delivery, the answer is "a very small percentage."

1.6 Volume and open interest

Volume is the number of contracts traded during a period. It counts transactions.

Open interest is the number of contracts currently outstanding — positions opened and not yet offset or delivered. It counts obligations.

Work out how open interest changes from who is doing what. Every trade has a buyer and a seller, and each is either opening a new position or closing an existing one:

Open interest starts a contract month's life at zero, builds as the market takes positions, and declines to zero at expiration. On the first day a new contract month trades, open interest is zero.

1.7 Convergence

As a contract approaches expiration, the futures price and the cash (spot) price of the underlying commodity come together. At expiration they are essentially equal.

The reason is arbitrage. If December wheat futures traded far above cash wheat on the last day, a trader would buy cash wheat, sell the future, and deliver — a riskless profit that pushes the two prices back together. The possibility of delivery is what ties the futures market to the physical market. Convergence is why hedging works at all, and Chapter 8's entire discussion of basis is really a discussion of the pace of convergence.

Practice questions

1.1 A futures contract differs from a forward contract primarily because the futures contract is: (A) negotiable as to quantity and grade; (B) standardized and traded on an exchange; (C) always settled by physical delivery; (D) exempt from CFTC regulation.

1.2 A new buyer purchases one contract from a trader who is liquidating an existing long position. What happens to volume and open interest?

1.3 Which of the following may not accept customer funds: FCM, IB, or clearing member?

1.4 Approximately what percentage of futures contracts is settled by physical delivery?

1.5 The process by which the clearinghouse becomes the buyer to every seller and the seller to every buyer is called __.

1.6 True or false: a speculator's role in the futures market is to assume risk that hedgers wish to transfer, and in doing so to add liquidity.

Answers

Chapter 2 — The Language of the Contract

Sixteen questions on this exam are terminology and basic functions. Some are asked as direct definitions; the rest are asked in the vocabulary of every other question on the test. If you are unsure what "the nearby" means, you will lose questions in chapters that have nothing to do with terminology. Learn this chapter cold.

2.1 Contract specifications

Every contract is defined by a specification set by the exchange. The exam expects you to read one and compute with it.

Tick arithmetic

This is the most common calculation on the exam, and it is asked in disguise dozens of ways.

$$\text{Tick value} = \text{minimum price fluctuation} \times \text{contract size}$$

$$\text{Profit or loss} = \text{price change} \times \text{contract size} \times \text{number of contracts}$$

Worked example — corn. Corn is 5,000 bushels, quoted in cents per bushel, minimum fluctuation ¼ cent. One tick is $0.0025 \times 5{,}000 = \$12.50$. A trader buys 3 corn at 442'0 and sells at 446'0 — a move of 4 cents.

$$\$0.04 \times 5{,}000 \times 3 = \$600 \text{ profit}$$

Worked example — gold. Gold is 100 troy ounces, minimum fluctuation $0.10 per ounce, so one tick is $10. A trader short 2 gold from \$2,410.00 covers at \$2,395.50, a favorable move of \$14.50 per ounce.

$$\$14.50 \times 100 \times 2 = \$2{,}900 \text{ profit}$$

Note the direction: the trader was short and the price fell, so the move is a gain. Always establish the side before you compute the sign.

Worked example — the E-mini S&P 500. The multiplier is \$50 per index point and the tick is 0.25 points, so one tick is \$12.50. Long 4 contracts from 5,240.00, sold at 5,262.50: a move of 22.50 points.

$$22.50 \times \$50 \times 4 = \$4{,}500 \text{ profit}$$

2.2 The vocabulary of price and time

Spot / cash price. The price for immediate delivery of the physical commodity.

Nearby (or lead) month. The contract month closest to expiration. The deferred, distant or back months are those further out.

Contango / carrying-charge market. Deferred months trade above nearby months. This is the normal condition for a storable commodity, because holding physical inventory costs money.

Backwardation / inverted market. Nearby months trade above deferred months. This signals current scarcity — the market is paying a premium for immediate supply.

Full carry. The condition in which the price difference between two months exactly equals the cost of carrying the commodity between them. The spread cannot exceed full carry by much, because anyone could buy the nearby, store it, and sell the deferred for a riskless profit.

Carrying charges

$$\text{Carrying charge} = \text{storage} + \text{insurance} + \text{interest (financing)}$$

Those three components — storage, insurance, interest — are the answer to a direct exam question. Note the asymmetry the exam likes: a carrying-charge market has a ceiling set by the cost of carry, but an inverted market has no theoretical limit to how far the nearby can trade above the deferred. You cannot arbitrage a shortage of a commodity that does not exist yet.

2.3 Order-flow and position vocabulary

Settlement price versus closing price. These are not synonyms. The settlement price is determined by the exchange according to its own rules — often a weighted average of trades in a closing period — and it is the price used to mark every account to market and to compute margin calls. This distinction shows up in margin questions.

2.4 Reading a quote

A futures quote table shows, per contract month: open, high, low, settlement, change from prior settlement, lifetime high and low, and open interest. The exam may hand you a table and ask you to compute a position's gain, identify the nearby month, or determine whether the market is in carrying-charge or inverted structure.

Worked example. Given:

Deferred months are progressively higher, so this is a carrying-charge (contango) market. The July–September spread is 9 cents. If the full cost of carry over those two months is 11 cents, the market is trading at less than full carry, and the spread has room to widen but is capped near 11.

2.5 Cash settlement versus physical delivery

Some contracts cannot be delivered. You cannot hand someone the S&P 500 index, a Eurodollar interest rate, or a weather statistic. These contracts settle in cash: at expiration, the final settlement price is set to a defined value of the underlying index or rate, accounts are marked to that value one final time, and the position simply disappears.

Physically delivered contracts — grains, livestock, metals, energy, Treasury securities — end with an actual transfer of the commodity or instrument through the exchange's delivery process, covered in Chapter 4.

2.6 Terms that are easily confused

The exam builds distractors out of near-synonyms. These pairs account for a large share of the terminology questions.

Practice questions

2.1 A silver contract is 5,000 troy ounces with a minimum fluctuation of \$0.005 per ounce. What is the value of one tick?

2.2 A trader is short 4 crude oil contracts (1,000 barrels each) from \$78.40 and buys them back at \$76.15. What is the gain or loss?

2.3 Deferred delivery months are trading below the nearby month. This market is described as _, and it typically signals _.

2.4 Name the three components of carrying charges.

2.5 True or false: in a carrying-charge market, the premium of the deferred month over the nearby has no theoretical upper limit.

2.6 A trader buys 2 E-mini S&P 500 contracts (\$50 multiplier) at 5,180.25 and sells at 5,168.75. Compute the result.

Answers

Chapter 3 — Margin and Marking to Market

Margin questions are pure arithmetic with one conceptual trap buried inside. Candidates who lose points here almost always lose them the same way — by restoring a deficient account to the wrong level. Learn the mechanic and this becomes free marks.

3.1 Margin is a performance bond, not a payment

In securities, margin is borrowed money: you pay part of the purchase price, the broker lends the rest, and you owe interest. Futures margin is nothing like that.

Futures margin is a good-faith deposit — a performance bond — that guarantees you can meet the daily obligations of your position. Nothing is borrowed, nothing is owed, and no interest is charged. You have not paid part of the contract value; you have posted security against the possibility of loss.

Margin levels are set by the exchange, which establishes minimums. An FCM may require more than the exchange minimum from a given customer but never less. Requirements rise when volatility rises.

3.2 The three margin terms

Maintenance margin is always lower than initial margin — typically around 70–75% of it. The gap between the two is deliberate: it gives a position room to move against you a little without generating a call on every tick.

The rule that fails candidates

When equity falls below maintenance, the customer receives a margin call and must restore the account to the initial margin level — not to the maintenance level.

Read that again, because the exam will offer you the maintenance level as a distractor and it will look reasonable. The amount of the call is:

$$\text{Margin call} = \text{initial margin requirement} - \text{current equity}$$

There is a second, quieter part of the same rule: a small loss that leaves equity above maintenance produces no call at all. Equity must actually drop below the maintenance level.

3.3 Marking to market

At the end of every trading session the exchange establishes a settlement price for each contract month. Every open position is then revalued at that price, and the resulting gain or loss is credited to or debited from the account in cash that day.

This daily settlement is what makes the clearinghouse guarantee credible. Losses are collected before they can accumulate; the clearinghouse never carries an unpaid loss overnight. It is also why futures accounts show gains as immediately withdrawable cash rather than as unrealized paper profits.

Worked example — the daily cycle. A trader buys 1 gold contract (100 oz) at \$2,400.00. Initial margin \$11,000; maintenance margin \$10,000. The account is funded with exactly \$11,000.

The call is not \$200 (the amount needed to get back to maintenance). It is:

$$\$11{,}000 - \$9{,}800 = \boxed{\$1{,}200}$$

The customer must deposit \$1,200 to restore the account to initial margin.

Worked example — excess equity. Same trader, but the price rises to \$2,412.00 on day 1. The gain is $12.00 \times 100 = \$1{,}200$, so equity is \$12,200 against an initial requirement of \$11,000. The customer may withdraw the \$1,200 excess in cash. This is the practical consequence of daily settlement: profits are real money immediately, not unrealized gains.

3.4 Speculative versus hedge margin

Hedge accounts receive lower margin requirements than speculative accounts in the same contract. The reasoning is that a bona fide hedger holds an offsetting position in the cash commodity, so the net economic risk is smaller.

To qualify, the account must be designated as a hedge account and the positions must be bona fide hedges of cash-market exposure. Expect a question that simply asks which account type has the lower requirement: the hedger's.

Spread margins are also lower than outright margins, because a long in one month against a short in another carries far less risk than either leg alone.

3.5 Option margin

Options on futures have a margin structure that follows directly from who bears the obligation.

The option buyer pays the premium in full at the time of purchase and posts no margin ever. The buyer's maximum possible loss is the premium already paid, so there is nothing further to secure. The buyer cannot receive a margin call.

The option seller (writer) has an open-ended obligation and therefore must post margin, and is subject to margin calls as the position moves against them. A short call has theoretically unlimited risk; a short put's risk is limited only by the underlying falling to zero.

3.6 The full vocabulary of an account

3.7 A complete worked problem

A customer sells 5 soybean contracts (5,000 bushels each) at \$13.40 per bushel. Initial margin is \$3,000 per contract; maintenance is \$2,200 per contract. The account holds exactly the initial requirement. Soybeans settle at \$13.62. What happens?

Step 1 — requirements. Initial: $5 \times \$3{,}000 = \$15{,}000$. Maintenance: $5 \times \$2{,}200 = \$11{,}000$.

Step 2 — the price move against the position. The customer is short and the price rose by \$0.22 per bushel — a loss.

$$\$0.22 \times 5{,}000 \times 5 = \$5{,}500 \text{ loss}$$

Step 3 — new equity. $\$15{,}000 - \$5{,}500 = \$9{,}500$.

Step 4 — test against maintenance. \$9,500 is below the \$11,000 maintenance level, so a margin call is issued.

Step 5 — the amount. Restore to initial, not maintenance:

$$\$15{,}000 - \$9{,}500 = \boxed{\$5{,}500}$$

Notice that when an account starts at exactly the initial requirement, the call equals the entire loss. That is a useful sanity check.

Practice questions

3.1 A customer buys 2 contracts. Initial margin is \$4,000 per contract and maintenance is \$3,000 per contract. The account holds \$8,000. The position loses \$2,400. Is there a margin call, and if so for how much?

3.2 Same facts, but the position loses \$2,600. Is there a margin call, and for how much?

3.3 True or false: futures margin is a partial payment toward the purchase price of the commodity.

3.4 Which requires more margin in the same contract — a hedge account or a speculative account?

3.5 A customer buys 10 crude oil call options at a premium of \$1.80 per barrel (1,000 barrels per contract). How much must the customer deposit, and can the customer later receive a margin call on this position?

3.6 A trader long 3 contracts has equity of \$21,500 against an initial requirement of \$18,000. What may the trader do?

Answers

Chapter 4 — Price Limits, Settlement, Delivery, Exercise and Assignment

This chapter finishes the 15-question mechanics block begun in Chapter 3. The material is procedural rather than conceptual: who does what, in what order, on which day. The exam rewards knowing the sequence.

4.1 Daily price limits

A daily price limit is the maximum amount a contract may advance or decline from the previous session's settlement price. Limits exist to give a violently moving market a pause, allowing information to circulate and margin to be collected in an orderly way.

Two points the exam presses on. First, a price limit does not stop the market from moving — it stops it from moving today. A market that would have fallen far can lock limit down for several sessions running, and a trapped short-side hedger or long speculator may be unable to exit at any price during that stretch. Second, the spot or delivery month typically has no price limit, or has its limits removed as delivery approaches, precisely so that futures can converge freely to the cash price.

4.2 The settlement price

At the close of each session the exchange establishes an official settlement price for every contract month, generally derived from trading activity during a defined closing period rather than simply the last trade.

The settlement price is used to:

• mark every open position to market and compute the day's variation margin,
• determine margin calls,
• set the reference from which the next day's price limits are measured,
• value positions for reporting.

Settlement price ≠ closing price. The closing price is the last trade; the settlement price is the exchange's official mark, determined under its rules. Margin is computed from the settlement price.

4.3 The delivery process

Only a small fraction of contracts reach delivery, but the exam tests the sequence carefully.

Who initiates

The short initiates delivery. The seller holds the obligation to deliver and chooses, within the rules of the contract, when during the delivery period to do so and — where the contract permits — which deliverable grade and which delivery location. This choice belongs to the short, not the long, and it is asked directly.

The clearinghouse then assigns the delivery notice to a long, conventionally the holder of the oldest outstanding long position in that contract month.

The sequence of days

A crucial practical point: first notice day often precedes last trading day. A long who does not want delivery must offset before first notice day, not merely before last trading day. Waiting until the last trading day can leave a long holding a delivery notice.

Delivery instruments

Delivery is generally accomplished not by physically moving the commodity but by transferring a warehouse receipt or shipping certificate — a document of title to commodity stored at an exchange-approved facility. Payment is made against the document.

Retendering

A long who receives a delivery notice and does not want the commodity may, under many contracts, retender the notice — pass it along to another long — subject to exchange rules and timing.

4.4 Cash settlement

Contracts on things that cannot be delivered settle in cash. At expiration the exchange determines a final settlement price from a defined value of the underlying — an index level, an average rate, a published cash price — marks all open positions to that value one last time, and the positions cease to exist. No commodity moves and no delivery notice is issued.

Cash-settled contracts on the exam include stock index futures, Eurodollar / SOFR-type short-term rate contracts, and various index products. Physically delivered contracts include grains, oilseeds, livestock, metals, energy and Treasury notes and bonds.

4.5 Ex-pit transactions: EFP

An Exchange for Physical (EFP), sometimes called an exchange for related position or "against actuals," is a privately negotiated transaction, permitted by exchange rules, in which two parties simultaneously exchange a futures position for the corresponding cash commodity position.

Its distinguishing features, all of which are testable:

• It is negotiated off the exchange floor / away from the central market (hence "ex-pit"), but it is reported to and cleared by the exchange.
• It involves both a futures leg and a cash leg between the same two parties.
• It lets a hedger convert a futures position into the physical commodity, with a counterparty of their choosing, at a negotiated price and location.

4.6 Options: exercise and assignment

Options on futures complete this mechanics block.

Exercise is the buyer's act. The holder of a call exercises to become long the underlying futures contract at the strike price; the holder of a put exercises to become short the underlying futures at the strike price.

Assignment is what happens to a writer. When an option is exercised, the clearinghouse assigns the obligation to a writer of that option, who is placed in the opposite futures position:

Style. Options on futures are typically American style — exercisable at any time up to expiration — in contrast to European style, exercisable only at expiration. Know both terms.

Automatic exercise. Options that are in the money at expiration are generally exercised automatically under exchange rules. An out-of-the-money option expires worthless and the writer keeps the premium.

What the writer cannot do. A writer cannot choose to be assigned or refuse assignment. The writer's only ways out are to be assigned, to have the option expire worthless, or to offset by buying back an identical option before assignment occurs.

4.7 Position limits, briefly

The exchanges and the CFTC establish speculative position limits — caps on the number of contracts a speculator may hold — and require reporting of positions above defined levels. Bona fide hedgers may apply for exemptions from speculative limits, since their positions offset cash exposure. This is regulatory material and is treated in full in Chapter 17; it appears here only because delivery-month limits are part of the mechanics of the expiring contract.

Practice questions

4.1 Who decides when, within the delivery period, delivery will be made — the long or the short?

4.2 A long who does not wish to take delivery must offset before which day?

4.3 A market is bid at limit up with no offers. This condition is called __.

4.4 A customer exercises a put option on corn futures with a 450 strike. What futures position does the customer now hold, and what position does the assigned writer hold?

4.5 Which of these is cash settled rather than physically delivered: soybean futures, gold futures, or S&P 500 index futures?

4.6 True or false: an EFP is negotiated privately between two parties and never reported to the exchange.

4.7 Why do exchanges typically remove or widen price limits in the delivery month?

Answers

Chapter 5 — Order Types and Customer Accounts

Order questions are the most mechanical points on the exam and the easiest to bank. Every one of them reduces to a single question: is this order placed above or below the current market, and what does it become when it is triggered? Get that framework straight and the whole topic collapses into a table.

5.1 The two orders everything else is built from

Market order. Buy or sell immediately at the best available price. It guarantees execution but not price. In a fast or thin market it can fill far from where the customer expected.

Limit order. Buy or sell at a specified price or better. It guarantees price but not execution. If the market never trades there — or trades there but not enough volume reaches your order — you do not get filled.

That trade-off is the whole of it: market orders trade certainty of price for certainty of execution, and limit orders do the reverse.

Where limits sit

A limit order only makes sense on the favorable side of the market:

• A buy limit is placed below the current market. You are willing to buy, but cheaper.
• A sell limit is placed above the current market. You are willing to sell, but dearer.

5.2 Stop orders

A stop order becomes a market order when the market trades at or through the stop price. It is the mirror image of a limit order in placement:

• A buy stop is placed above the current market.
• A sell stop is placed below the current market.

Stops are used to limit a loss on an existing position or to enter on a breakout. A long protects with a sell stop below; a short protects with a buy stop above.

Stop limit order. Becomes a limit order rather than a market order when elected. It solves the slippage problem and creates a worse one: the order may never fill, leaving the customer in a losing position with no protection. Know both halves of this trade-off.

5.3 Market-if-touched (MIT)

An MIT order becomes a market order when the market touches the specified price. Its placement is the opposite of a stop, and this is precisely why the exam likes it:

• A buy MIT is placed below the current market.
• A sell MIT is placed above the current market.

An MIT is used to enter or exit at a favorable level while guaranteeing execution once the level trades — where a limit order at the same price might be passed over.

The placement table — memorize this

The pattern worth carrying into the exam room: stops are placed against you, limits and MITs are placed in your favor. A buy stop is above (you pay up); a buy limit and buy MIT are below (you pay less).

5.4 Time and condition qualifiers

Cancel and cancel/replace. A straight cancel removes an order. A cancel/replace (or "cancel former order," CFO) substitutes new terms for an existing order — the original is cancelled and the replacement takes its place.

5.5 Customer accounts

Discretionary accounts

A discretionary account is one in which someone other than the account owner — an AP, a CTA, a broker — may enter orders without the customer's prior approval of each trade. Because the potential for abuse is obvious, the requirements are strict and heavily tested:

1. A written power of attorney (or trading authorization) signed by the customer, specifically granting discretion.
2. Written approval of the account by a designated partner, officer or branch manager of the firm.
3. Frequent and systematic review of the account by that supervisory person, specifically for churning (excessive trading to generate commissions) and for suitability.
4. The account must be specifically designated as discretionary in the firm's records, and orders entered under discretion must be marked as such.

The exam distinguishes discretion over price and time from discretion over the trade itself. Telling a broker "buy one December corn, you pick the moment" is time and price discretion and does not require a formal power of attorney. Authority to decide what and whether to trade does.

5.6 What must be obtained when the account is opened

Chapter 15 covers the regulatory detail. For now, the essentials:

• A signed customer agreement.
• The Risk Disclosure Statement — furnished and acknowledged before the account may trade.
• Know-your-customer information: name, address, occupation, financial condition, trading experience and objectives.
• For discretionary accounts, the written power of attorney and firm approval described above.
• For hedge accounts, the customer's representation of bona fide hedging.

Practice questions

5.1 December wheat is trading at 612. A customer who is long wants to protect against a decline. What order type does the customer use, and is it placed above or below 612?

5.2 A customer wants to buy silver but only if it trades down to 2850. Which two order types could accomplish this, and how do they differ?

5.3 A sell stop at 1,240 is elected in a rapidly falling market and the next trade is 1,228. At approximately what price does the order fill?

5.4 Which order guarantees execution but not price? Which guarantees price but not execution?

5.5 An account is opened in which a CTA will enter orders without consulting the customer on each trade. Name three requirements.

5.6 True or false: a "not held" order makes an account discretionary and requires a written power of attorney.

5.7 Two co-owners hold an account as tenants in common. One dies. Who receives that owner's share?

Answers

Chapter 6 — Price Analysis: Fundamental and Technical

The exam does not ask you to be a good analyst. It asks you to know which school of analysis a given tool belongs to, and to read one specific table — the relationship between price, volume and open interest — correctly. Study accordingly.

6.1 The two schools

Fundamental analysis studies supply and demand to determine what a price should be. The fundamental analyst asks: how large is the crop, how big is the carryover, what is export demand, what did the government report say, what is the herd size, what will the Fed do?

Technical analysis studies market action itself — price, volume and open interest — to forecast where price is going, on the premise that everything knowable is already reflected in the price and that patterns of market behavior repeat.

A clean way to hold the distinction: fundamentals explain why; technicals describe what. Sorting a tool into the right column is a standard exam question.

6.2 Core fundamental concepts

Supply and demand. Price rises when demand exceeds supply at the current price and falls when supply exceeds demand. Everything else is elaboration.

Carryover (ending stocks). The quantity of a commodity left over at the end of a marketing year and carried into the next. Large carryover is bearish — it cushions supply. Small carryover is bullish — the market has no margin for error.

The stocks-to-use ratio. Ending stocks divided by total usage. A low ratio means a tight market, sensitive to any supply shock. The relationship is inverse: low stocks-to-use tends to mean high and volatile prices.

Elasticity. How much quantity demanded or supplied responds to price. Inelastic demand — characteristic of food staples and energy — means consumers keep buying even as prices rise, so small supply changes produce large price swings. This is why agricultural and energy markets are so volatile.

Seasonality. Production of a storable crop arrives all at once at harvest while consumption spreads over the year. Prices are therefore often lowest at harvest and rise through the storage season, reflecting accumulating carrying charges.

Government reports. USDA crop production, planting intentions, grain stocks and WASDE reports; for financial futures, employment, inflation and Federal Reserve policy. The exam's interest is simply that these are fundamental inputs.

6.3 Core technical concepts

Support. A price area where buying has previously been sufficient to stop declines. Resistance is where selling has stopped advances. A broken resistance level frequently becomes support afterward, and vice versa.

Trend and trendline. An uptrend is a series of higher highs and higher lows, and its trendline is drawn along the lows. A downtrend is lower highs and lower lows, with the trendline drawn along the highs. Penetration of a trendline signals possible reversal.

Chart types. The bar chart plots open, high, low and close against time. The point-and-figure chart plots price movement only, in columns of X's (advances) and O's (declines), ignoring time entirely — that last detail is the tested one.

Moving averages. An average of the last n closing prices, recalculated each period, used to smooth noise and identify trend. A price crossing above its moving average, or a short average crossing above a longer one, is read as bullish; the reverse is bearish. Moving averages are lagging indicators — they confirm rather than predict.

Gaps. A price range in which no trading occurred, appearing on the chart as a space between one session's range and the next.

Formations. Head and shoulders (a reversal pattern), double tops and bottoms, triangles, flags and pennants (usually continuation patterns).

6.4 Volume, open interest and price — the table the exam asks

This is the single most reliably tested item in the chapter. The logic: rising open interest means new money is entering and committing to the trend, which confirms it. Falling open interest means positions are being liquidated, which weakens the trend regardless of what price is doing.

Two shortcuts that answer most versions of the question:

• Rising open interest confirms the existing price trend, whatever its direction.
• Falling open interest suggests the trend is losing conviction — the move is being driven by people getting out rather than people getting in.

6.5 Fitting the tool to the school

Most price-analysis questions on this exam are classification questions dressed up as scenarios. If the stem describes anything derived from price, volume or open interest, it is technical. If it describes anything about the physical or economic state of the world — weather, acreage, herd size, interest rates, government policy, consumption — it is fundamental.

The one that catches people: open interest and volume are technical, even though they come from exchange data rather than a chart. They are market-action data, not supply-and-demand data.

Practice questions

6.1 Classify each as fundamental or technical: (a) USDA planting intentions report; (b) a head-and-shoulders formation; (c) the stocks-to-use ratio; (d) a 20-day moving average; (e) open interest.

6.2 Prices are advancing while open interest declines. How does a technician interpret this?

6.3 Which chart type disregards the passage of time?

6.4 Carryover stocks come in far above expectations. Is this bullish or bearish, and why?

6.5 In an uptrend, is the trendline drawn along the highs or the lows?

6.6 Demand for a commodity is highly inelastic. What does this imply about the price effect of a small reduction in supply?

6.7 Price is falling, volume is rising and open interest is rising. Interpret.

Answers

Chapter 7 — The Hedge: Long, Short, and Why It Works

Hedging and basis together are 19 questions — the largest single topic in Part 1, worth more than options, spreads and price analysis combined. If you have limited study time, this chapter and the next are where it goes.

7.1 What a hedge is

A hedge is a futures position taken equal in size and opposite in direction to an existing or anticipated position in the cash commodity, for the purpose of offsetting the risk of an adverse price change.

The mechanism is simple: cash and futures prices tend to move together, so a loss in one market is largely offset by a gain in the other. The hedger gives up the chance of a windfall from a favorable price move in exchange for protection against an unfavorable one.

The single question that determines everything. Ask: does this person suffer if prices rise, or if prices fall?

• Suffers if prices fall → they own or will own the commodity → short hedge (sell futures).
• Suffers if prices rise → they will buy the commodity later → long hedge (buy futures).

Every hedging question on this exam is that question in costume.

7.2 The short hedge (selling hedge)

A short hedge is used by someone who owns the commodity, or will own it, and is therefore exposed to falling prices. They sell futures now.

Who uses a short hedge:

• A farmer with a growing crop, or grain in the bin
• A grain elevator holding inventory
• A cattle feeder with animals on feed
• A copper mine with production coming
• An oil producer with reserves to sell
• A portfolio manager holding stocks who fears a market decline (sells stock index futures)
• A bond dealer holding an inventory of Treasuries who fears rising interest rates

Worked example — the short hedge. In June, a farmer expects to harvest 10,000 bushels of corn in November. Cash corn is \$4.50; December corn futures are \$4.70. Fearing a price decline, the farmer sells 2 December corn futures (5,000 bushels each).

By November, prices have fallen. The farmer sells the cash crop at \$4.05 and buys back the futures at \$4.25.

$$\text{Net selling price} = \$4.05 + \$0.45 = \$4.50 \text{ per bushel}$$

The \$0.45 futures gain offset the \$0.45 decline in the cash market almost exactly. The farmer achieved roughly the price available in June, which is precisely what the hedge was for.

And if prices had risen instead? Suppose cash went to \$5.00 and futures to \$5.20. The farmer sells cash at \$5.00 — \$0.50 better — but loses \$0.50 on the futures. Net: \$4.50 again. The hedge works in both directions. It locks in a price; it does not let you keep the upside. A question asking "what if the hedger was wrong about direction?" is testing whether you understand that this is a feature, not a failure.

7.3 The long hedge (buying hedge)

A long hedge is used by someone who will buy the commodity later and is therefore exposed to rising prices. They buy futures now.

Who uses a long hedge:

• A miller or baker who will buy wheat
• A food processor who will buy soybean oil
• A meat packer who will buy livestock
• A jeweler or manufacturer who will buy metal
• An airline that will buy jet fuel
• An importer who will need foreign currency
• A portfolio manager expecting a cash inflow who wants to lock in current stock prices (buys index futures) — an anticipatory hedge
• A borrower who fears rising interest rates, or a lender/investor who fears falling rates on money to be invested

Worked example — the long hedge. In March, a cereal manufacturer knows it will buy 50,000 bushels of wheat in July. Cash wheat is \$6.10; July futures are \$6.30. Fearing higher prices, the firm buys 10 July wheat futures (5,000 bushels each).

By July, prices have risen. The firm buys cash wheat at \$6.65 and sells the futures at \$6.85.

$$\text{Net purchase price} = \$6.65 - \$0.55 = \$6.10 \text{ per bushel}$$

The firm effectively bought its wheat at March's price.

7.4 The summary table

7.5 Variations the exam names

Anticipatory hedge. A hedge placed against a cash position the hedger does not yet hold but firmly expects — a crop not yet harvested, a purchase not yet made, an inflow not yet received. Both of the worked examples above are anticipatory.

Cross hedge. Hedging a cash commodity with futures on a different but related commodity, because no futures contract exists on the exact item. A jet-fuel buyer hedging with heating oil futures; a feed buyer hedging a byproduct with corn futures. The two prices are correlated but not identical, so a cross hedge carries greater basis risk than a direct hedge. That is the tested point.

Selective hedging. Hedging only part of the time, or only part of the position, based on a view of the market. The exam treats this as a partly speculative activity — the moment a hedger chooses whether to hedge based on a price forecast, they are taking a view rather than eliminating risk.

Texas hedge. Not a hedge at all: buying futures while already long the cash commodity, which doubles the exposure rather than offsetting it. If a question describes someone long cash and long futures, the position is speculative, not hedged.

7.6 The hedge ratio

The simplest hedge matches the cash quantity exactly:

$$\text{Number of contracts} = \frac{\text{cash quantity to hedge}}{\text{contract size}}$$

A producer with 27,000 bushels of corn and a 5,000-bushel contract needs $27{,}000 / 5{,}000 = 5.4$ contracts, and must round to 5 or 6. Rounding down leaves part of the position unhedged; rounding up over-hedges, leaving the excess as a speculative position.

For stock index hedging, the quantity is adjusted for beta — how much the portfolio moves relative to the index (Chapter 13):

$$\text{Contracts} = \frac{\text{portfolio value}}{\text{index level} \times \text{multiplier}} \times \beta$$

7.7 What a hedge does not do

Three statements the exam wants you to affirm:

1. A hedge does not guarantee a profit. It fixes a price. If that price is below the cost of production, the hedger locks in a loss — and has still hedged correctly.
2. A hedge does not eliminate all risk. It substitutes basis risk for price risk. The hedger no longer cares much about the level of prices, but now cares about the relationship between cash and futures. That relationship is the subject of Chapter 8, and it is where the remaining risk lives.
3. A hedge forfeits favorable price moves. Protection against adverse moves is paid for by giving up beneficial ones. A hedger who complains about missing a rally has misunderstood the transaction.

The regulatory benefits, by contrast, are real and tested: bona fide hedgers receive lower margin requirements and may obtain exemptions from speculative position limits.

Practice questions

7.1 A copper fabricator will purchase 100,000 pounds of copper in four months and fears rising prices. What hedge, and what futures action?

7.2 A soybean farmer with a growing crop fears falling prices. What hedge, and what futures action?

7.3 A pension fund manager holding a large equity portfolio expects a market decline over the next quarter but does not want to sell the stocks. What should the manager do with stock index futures?

7.4 A corporate treasurer will issue bonds in three months and fears rising interest rates. Should the treasurer buy or sell interest rate futures?

7.5 In May, an elevator holds wheat and sells July futures at \$6.40. In July it sells the cash wheat at \$5.90 and buys back the futures at \$6.05. What net price did the elevator receive?

7.6 An airline hedges jet fuel using heating oil futures. What is this called, and what additional risk does it carry?

7.7 True or false: a properly constructed hedge eliminates all risk from the hedger's position.

7.8 A trader is long 20,000 bushels of cash corn and also buys 4 corn futures contracts. Describe this position.

Answers

Chapter 8 — Basis: The Number the Exam Loves

Basis is the most reliably tested calculation on the Series 3. It is also the concept most candidates half-learn — they memorize the formula and then guess at whether a change helps or hurts a given hedger. This chapter is built so you never have to guess.

8.1 The definition — memorize the direction

$$\boxed{\text{Basis} = \text{Cash price} - \text{Futures price}}$$

Cash minus futures. Not the other way around. Every conclusion in this chapter inverts if you reverse it, and the exam supplies distractors built on exactly that error.

Basis is quoted as a number "over" or "under":

• Cash \$4.30, futures \$4.50 → basis is −\$0.20, spoken as "20 under."
• Cash \$4.65, futures \$4.50 → basis is +\$0.15, spoken as "15 over."

For a storable commodity in a normal carrying-charge market, cash trades below futures and the basis is negative. The size of that discount reflects storage, insurance and interest between now and the delivery month, plus local transportation and quality differences.

8.2 Strengthening and weakening

The words are about the number's value, on a number line, not its absolute size.

A basis moving from −0.30 to −0.15 has strengthened, even though the cash price may have fallen. What matters is that cash gained relative to futures.

8.3 Who is helped by which — the formula that settles it

Rather than memorizing a rule, derive it once. For a short hedger: they sell futures at $F_0$, later sell cash at $C_1$ and buy back futures at $F_1$.

$$\text{Net price} = C_1 + (F_0 - F_1) = F_0 + (C_1 - F_1) = F_0 + B_1$$

For a long hedger: they buy futures at $F_0$, later buy cash at $C_1$ and sell futures at $F_1$.

$$\text{Net cost} = C_1 - (F_1 - F_0) = F_0 + (C_1 - F_1) = F_0 + B_1$$

Both land on the same beautiful result:

$$\boxed{\text{Net price} = \text{Futures price when the hedge was placed} + \text{Basis when the hedge was lifted}}$$

Now the rule is obvious rather than memorized. $F_0$ is already fixed the moment the hedge is placed, so the only uncertainty left is the ending basis — which is precisely why hedging substitutes basis risk for price risk.

• The short hedger is selling. A higher net price is better. Higher ending basis is better. → A strengthening basis benefits the short hedger.
• The long hedger is buying. A lower net cost is better. Lower ending basis is better. → A weakening basis benefits the long hedger.

If you would rather carry a mnemonic: short hedgers want it strong. Both words start the same way.

8.4 Worked examples

Example 1 — short hedge, strengthening basis

In September an elevator owns wheat. Cash is \$5.80; December futures are \$6.10. Basis is −\$0.30. The elevator sells December futures.

In November it sells the cash wheat at \$5.95 while December futures are \$6.15. Ending basis is $\$5.95 - \$6.15 = -\$0.20$ — the basis strengthened by \$0.10.

$$\text{Net} = \$5.95 - \$0.05 = \$5.90$$

Check with the shortcut: $F_0 + B_1 = \$6.10 + (-\$0.20) = \$5.90$. ✓

Compare with the expected outcome had the basis been unchanged at −\$0.30: $\$6.10 - \$0.30 = \$5.80$. The \$0.10 of basis strengthening improved the elevator's realized price by exactly \$0.10. Strengthening basis, short hedger, better result.

Example 2 — long hedge, weakening basis

In April a processor will buy soybeans in August. Cash is \$13.20; September futures are \$13.50. Basis is −\$0.30. The processor buys September futures.

In August it buys cash at \$13.90 while September futures are \$14.35. Ending basis is $\$13.90 - \$14.35 = -\$0.45$ — the basis weakened by \$0.15.

$$\text{Net cost} = \$13.90 - \$0.85 = \$13.05$$

Check: $F_0 + B_1 = \$13.50 + (-\$0.45) = \$13.05$. ✓

Against an unchanged basis the processor would have paid $\$13.50 - \$0.30 = \$13.20$. The weakening basis saved \$0.15. Weakening basis, long hedger, better result.

Example 3 — the exam's favorite shortcut question

A short hedger places a hedge when the basis is 25 under and lifts it when the basis is 10 under. How is the result affected?

The basis went from −0.25 to −0.10 — it strengthened by 15 cents. The short hedger gains 15 cents relative to the price implied at the original basis. No other information is needed; you do not need cash prices, futures prices, or the direction of the market.

This is the whole trick: the change in basis is the change in the hedger's net result, with the sign determined by which side they are.

8.5 Convergence and why basis is more predictable than price

As delivery approaches, cash and futures converge, so basis approaches zero at the delivery point. A hedger holding a position into the delivery month therefore has a fairly good idea of where the basis will end up, even though they have no idea where the price will be.

This is the deepest point in the chapter. The hedger has traded a large, unpredictable risk (the absolute level of prices, which can move dollars) for a small, comparatively predictable one (the basis, which moves in cents and tends toward zero). That trade is the entire economic value of hedging.

Basis is influenced by:

• Carrying charges — storage, insurance and interest to the delivery month
• Local supply and demand at the cash location
• Transportation costs from the cash location to the delivery point
• Quality differences between the local commodity and the deliverable grade
• Time remaining to delivery — basis narrows as expiration nears

8.6 Basis risk

Basis risk is the risk that the basis changes unfavorably between placing and lifting a hedge. It is what remains after price risk is hedged away.

It is larger when:

• the hedge is a cross hedge (different commodity),
• the cash location is far from the delivery point,
• the cash grade differs materially from the deliverable grade,
• the hedge is lifted well before the delivery month.

It is smaller when the cash commodity, location and timing align closely with the contract's delivery specifications.

Practice questions

8.1 Cash cotton is 71.40 and December futures are 73.90. State the basis in both notations.

8.2 The basis moves from 18 under to 6 under. Has it strengthened or weakened, and by how much?

8.3 A long hedger placed a hedge at a basis of 12 under and lifted it at 22 under. Was the hedger helped or hurt, and by how much?

8.4 A short hedger sells May futures at \$4.85 when the basis is 20 under. The hedge is lifted when the basis is 8 under. What net price is realized?

8.5 In June a feedlot buys August cattle futures at 178.50 to hedge a future purchase. In August it buys cash cattle at 182.00 and sells the futures at 183.75. Compute the net purchase price and the ending basis.

8.6 True or false: a strengthening basis means cash prices have risen.

8.7 Which carries more basis risk — a Kansas wheat elevator hedging with a wheat contract deliverable in Kansas, or an airline hedging jet fuel with heating oil futures? Why?

8.8 Explain, in one sentence, why hedging is worthwhile even though it does not eliminate risk.

Answers

A note on the shortcut formula. $\text{Net} = F_0 + B_1$ is exact whenever the hedge is placed and lifted in the same futures contract month, with $F_0$ the futures price at initiation and $B_1$ the basis at liquidation. It holds for long and short hedgers alike.

Use it when the question hands you a futures price and a basis — the exam's usual framing, as in 8.4. Use the two-leg table when you are given cash and futures prices on both dates, as in 8.5; it is slower but harder to get wrong under time pressure. If the two methods ever disagree, you have paired a price with the wrong date. Rebuild the table and the error will be visible.

Chapter 9 — Speculating: Leverage, P&L and Risk

Sixteen questions — 13% of the exam — and the great majority of them are arithmetic. Compute carefully, establish the side of the market before you take a sign, and this is the highest-yield block on the test per hour of study.

9.1 The speculator's role

A speculator has no position in the cash commodity. They take on price risk deliberately, in pursuit of profit, and in doing so perform two economic functions the exam credits them with:

1. Assuming risk that hedgers wish to transfer.
2. Providing liquidity and depth, so hedgers can enter and exit at fair prices whenever they need to.

Types the exam names:

9.2 Leverage — the central idea

Futures margin is a small fraction of the contract's total value, typically in the range of 2–10%. This means a small percentage change in price produces a large percentage change in the trader's equity — in both directions.

$$\text{Contract value} = \text{price} \times \text{contract size}$$

$$\text{Margin as \% of value} = \frac{\text{initial margin}}{\text{contract value}}$$

$$\text{Return on margin} = \frac{\text{profit or loss}}{\text{initial margin}}$$

Worked example. Gold is \$2,400 per ounce; the contract is 100 ounces; initial margin is \$11,000.

$$\text{Contract value} = \$2{,}400 \times 100 = \$240{,}000$$ $$\text{Margin \%} = \frac{\$11{,}000}{\$240{,}000} = 4.6\%$$

Now the price rises 5%, to \$2,520.

$$\text{Profit} = \$120 \times 100 = \$12{,}000$$ $$\text{Return on margin} = \frac{\$12{,}000}{\$11{,}000} = 109\%$$

A 5% price move produced a 109% return on margin — the leverage factor is roughly $1/0.046 \approx 22$ to one. Had the price fallen 5%, the trader would have lost \$12,000 against \$11,000 posted: the entire deposit plus a debit balance owed to the firm.

9.3 Long versus short risk

That asymmetry — the short's risk is theoretically unlimited — is asked directly and often. Note that this is the same structure as options: the short call has unlimited risk for exactly the same reason.

9.4 Profit and loss arithmetic

$$\text{P\&L} = (\text{exit price} - \text{entry price}) \times \text{contract size} \times \text{contracts}$$

...for a long, and the negative of that for a short. Or, avoiding sign errors entirely:

1. Determine the size of the price move.
2. Ask whether that move was favorable or unfavorable to the position's direction.
3. Multiply the move by contract size and number of contracts.
4. Apply the sign from step 2.

Worked example — long, multiple contracts. Buy 5 wheat (5,000 bu) at \$6.24, sell at \$6.51. Move: 27 cents, favorable to a long.

$$\$0.27 \times 5{,}000 \times 5 = \$6{,}750 \text{ profit}$$

Worked example — short, with a loss. Sell 3 crude oil (1,000 bbl) at \$74.20, cover at \$76.85. Move: \$2.65, unfavorable to a short.

$$\$2.65 \times 1{,}000 \times 3 = \$7{,}950 \text{ loss}$$

Worked example — return on margin. Sell 2 E-mini S&P 500 (\$50 multiplier) at 5,310.00, cover at 5,268.00. Initial margin \$14,000 per contract. Move: 42.00 points, favorable to a short.

$$42.00 \times \$50 \times 2 = \$4{,}200 \text{ profit}$$ $$\text{Return on margin} = \frac{\$4{,}200}{\$28{,}000} = 15\%$$

Worked example — commissions. Exams sometimes include a round-turn commission. Buy 4 soybean oil contracts (60,000 lb), gain \$0.0085 per pound, commission \$12 per round turn per contract.

$$\text{Gross} = \$0.0085 \times 60{,}000 \times 4 = \$2{,}040$$ $$\text{Net} = \$2{,}040 - (4 \times \$12) = \$1{,}992$$

A round turn covers both entry and exit — it is charged once per contract for the complete trade, not twice.

9.5 Managing speculative risk

Stop orders. The standard tool. A long protects with a sell stop below the market; a short with a buy stop above. Remember from Chapter 5 that a stop becomes a market order and so guarantees no price — and in a locked-limit market may not execute at all.

Diversification across unrelated commodities reduces the impact of any single market.

Position sizing. Committing only a portion of capital to margin, holding reserves against adverse moves and margin calls.

Pyramiding. Adding to a winning position with the profits it generates. The exam's view: it increases both potential return and risk, and the standard prudent form adds progressively smaller increments so the average entry price is not pushed too close to the current market. An inverted pyramid — adding larger increments — is the dangerous version.

9.6 Speculative position limits

Speculators are subject to speculative position limits set by the exchanges and the CFTC, and must report positions above defined levels. Bona fide hedgers may apply for exemptions, since their positions offset cash exposure. Full treatment is in Chapter 17.

Practice questions

9.1 A trader buys 3 corn contracts (5,000 bu) at \$4.38 and sells them at \$4.19. Compute the result.

9.2 A trader sells 2 gold contracts (100 oz) at \$2,388.00 and covers at \$2,341.50. Compute the result.

9.3 Silver is \$29.60 per ounce, contract size 5,000 ounces, initial margin \$16,000. What percentage of contract value is the margin, and what is the approximate leverage factor?

9.4 Using the figures in 9.3, a trader buys one contract and silver rises to \$31.40. Compute the profit and the return on margin.

9.5 Which has theoretically unlimited risk: a long futures position or a short futures position?

9.6 True or false: a futures speculator can never lose more than the margin originally deposited.

9.7 A trader buys 6 live cattle contracts (40,000 lb) at 176.20 cents per pound and sells at 174.85. Round-turn commission is \$15 per contract. Compute the net result.

Answers

Chapter 10 — Spreads

Read the weight badge above carefully: spreading is 3 questions out of 120. It is interesting material that rewards study poorly. This chapter is deliberately the shortest in the book. Learn the classifications, the bull/bear convention, and the two product spreads, then move on to regulations — where the marginal question is worth twelve times as much.

10.1 What a spread is

A spread is the simultaneous purchase of one futures contract and sale of a related one. The spreader is not betting on direction; they are betting on the change in the price difference between the two legs.

Two consequences the exam wants:

• Lower risk than an outright position, because a general move in the market affects both legs in the same direction and largely cancels.
• Lower margin requirements than either leg held outright, for the same reason.

10.2 The three classifications

10.3 Bull and bear spreads

The naming convention refers to which leg you expect to gain relative to the other.

Bull spread: long the nearby, short the deferred. It profits when the nearby gains on the deferred — that is, when the spread narrows in a carrying-charge market, or the market moves toward inversion. Bullish conditions (tight nearby supply) tend to do exactly that.

Bear spread: short the nearby, long the deferred. It profits when the deferred gains on the nearby — when the spread widens toward full carry. Bearish conditions (ample nearby supply) tend to produce that.

The reasoning worth carrying in, rather than the label. In a shortage, the nearby month reacts most violently, because the scarcity is immediate — you cannot arbitrage a commodity that does not exist yet. In a glut, the nearby sags toward the cost of carry while the deferred is anchored. So: bullish news moves the nearby more; be long the nearby. That derivation survives exam pressure better than the memorized phrase does.

Recall from Chapter 2 the asymmetry that makes this work: a carrying-charge spread is capped near full carry by arbitrage, but an inverted market has no theoretical limit. A bull spread therefore has a bounded downside and an open-ended upside in a storable commodity — which is precisely why bull spreads are more commonly discussed.

10.4 Computing a spread result

Track the two legs separately and add. Sign errors are the only real hazard.

Worked example. A trader buys July corn at \$4.52 and sells December corn at \$4.71 — the spread is 19 cents (December over). Later, July is \$4.68 and December is \$4.79 — the spread has narrowed to 11 cents.

The 8-cent gain is exactly the narrowing of the spread from 19 to 11 cents. On a 5,000-bushel contract that is $\$0.08 \times 5{,}000 = \$400$.

This was a bull spread — long nearby, short deferred — and it profited because the spread narrowed. The shortcut: the net result equals the change in the spread, with the sign set by whether you were long or short the nearby.

10.5 The commodity-product spreads

Two named spreads exploit the relationship between a raw commodity and the products refined from it. Both appear on the exam by name.

The soybean crush. Soybeans are processed into soybean meal and soybean oil. The crush spread is long soybeans / short meal and oil, capturing the processor's gross margin; the reverse crush is the opposite. A processor's natural hedge is to buy beans and sell the products.

The crack spread. Crude oil is refined into gasoline and heating oil. The crack spread is long crude / short products — or, for a refiner hedging their actual margin, the reverse: buy crude futures and sell product futures in the ratio their refinery produces.

The exam rarely asks for the ratios. It asks you to recognize the names and the commodities involved.

10.6 Spread orders

A spread order is entered as a single instruction specifying the price difference rather than two absolute prices — "buy July / sell December corn at 15 cents, December over." The order fills only when both legs can be executed at that differential, which protects the trader from "legging in" and ending up with only one side.

Practice questions

10.1 Classify: long March cocoa / short May cocoa on the same exchange.

10.2 Classify: long July soybeans / short July corn.

10.3 A trader is long the nearby and short the deferred. What is this spread called, and what does it profit from?

10.4 A trader buys September wheat at \$6.10 and sells December wheat at \$6.32. Later, September is \$6.32 and December is \$6.44. Compute the result per contract (5,000 bushels).

10.5 Which requires less margin — an outright long position or a spread?

10.6 Name the two commodities produced in the soybean crush.

Answers

Chapter 11 — Options on Futures: Fundamentals

The blueprint assigns 5 questions to option hedging, speculating and spreading — but that understates options' real weight. Premiums, intrinsic value, exercise and assignment also sit inside the 15-question mechanics block of Chapters 3 and 4. Treat options as worth roughly ten questions, not five.

11.1 The two contracts

A call option gives the buyer the right, but not the obligation, to buy the underlying futures contract at the strike price.

A put option gives the buyer the right, but not the obligation, to sell the underlying futures contract at the strike price.

Note carefully what is bought or sold on exercise: a futures position, not the physical commodity. Exercising a call makes you long futures at the strike; exercising a put makes you short futures at the strike.

Rights versus obligations

The buyer's risk is limited to the premium and the buyer never posts margin. The writer's position is the mirror image: limited gain, large or unlimited risk, margin required. This asymmetry generates a large share of the option questions on the exam.

11.2 Moneyness

Calls and puts are exact opposites here. The reliable check: an option is in the money when exercising it would be better than transacting at the current market price.

11.3 Premium = intrinsic value + time value

$$\boxed{\text{Premium} = \text{Intrinsic value} + \text{Time value}}$$

Intrinsic value is the amount by which the option is in the money — the value that would be realized on immediate exercise:

$$\text{Call intrinsic} = \max(0,\ \text{futures price} - \text{strike})$$ $$\text{Put intrinsic} = \max(0,\ \text{strike} - \text{futures price})$$

Intrinsic value can never be negative. An out-of-the-money option has zero intrinsic value, not negative intrinsic value. This is a favorite distractor.

Time value (extrinsic value) is everything else — what a buyer pays for the possibility that the option moves further into the money before expiration.

$$\text{Time value} = \text{Premium} - \text{Intrinsic value}$$

Worked example. December corn futures are \$4.62. A December 450 call is trading at \$0.19.

$$\text{Intrinsic} = \$4.62 - \$4.50 = \$0.12 \qquad \text{Time value} = \$0.19 - \$0.12 = \$0.07$$

Worked example — out of the money. With the same futures price of \$4.62, a December 480 call trades at \$0.05.

$$\text{Intrinsic} = \max(0,\ \$4.62 - \$4.80) = \$0.00 \qquad \text{Time value} = \$0.05$$

The entire premium of an out-of-the-money option is time value.

Worked example — a put. Gold futures are \$2,380. A 2,400 put trades at \$34.

$$\text{Intrinsic} = \$2{,}400 - \$2{,}380 = \$20 \qquad \text{Time value} = \$34 - \$20 = \$14$$

11.4 What moves the premium

Two points the exam presses:

Volatility raises both calls and puts. Greater expected movement increases the chance of finishing deeply in the money, and the buyer's downside is capped at the premium either way. Higher volatility, higher premium, always, for both types.

Time decay is not linear. Time value erodes slowly at first and accelerates as expiration approaches, collapsing to zero at expiration — at which point an option is worth exactly its intrinsic value. Time value is greatest for at-the-money options, because that is where the outcome is most uncertain.

11.5 Computing dollar amounts

Option premiums are quoted in the same units as the underlying futures, so the dollar value uses the same contract multiplier.

$$\text{Premium in dollars} = \text{quoted premium} \times \text{contract size}$$

Worked example. A soybean option (5,000 bushels) is quoted at \$0.24.

$$\$0.24 \times 5{,}000 = \$1{,}200 \text{ per contract}$$

A buyer of 3 such options pays $3 \times \$1{,}200 = \$3{,}600$ in full, up front, with no margin and no possibility of a margin call. That \$3,600 is also the buyer's maximum possible loss.

11.6 Exercise, assignment and expiration

Reviewing Chapter 4 in option-specific terms:

• Exercise is the buyer's act; assignment is what happens to a writer.
• Exercising a call → buyer long futures at the strike; assigned writer short futures.
• Exercising a put → buyer short futures at the strike; assigned writer long futures.
• Options on futures are typically American style — exercisable any time before expiration.
• In-the-money options are generally exercised automatically at expiration under exchange rules.
• Out-of-the-money options expire worthless; the writer keeps the entire premium.
• A writer cannot refuse assignment. The only exits are assignment, expiration, or offsetting by buying back an identical option.

11.7 Why a hedger might prefer options

This connects Chapters 7–8 to what follows. A futures hedge locks in a price in both directions: it removes the adverse move and the favorable one together. An option hedge is asymmetric — it establishes a floor or a ceiling while leaving the favorable direction open — and the premium is the price of that asymmetry.

A producer who buys puts has established a floor under their selling price while keeping the upside if prices rally. A processor who buys calls has established a ceiling on their purchase price while keeping the benefit if prices fall. Chapter 12 works both.

Practice questions

11.1 July wheat futures are \$6.40. A July 620 call trades at \$0.34. Compute intrinsic value and time value.

11.2 July wheat futures are \$6.40. A July 620 put trades at \$0.11. Compute intrinsic value and time value.

11.3 A customer exercises a call on silver futures with a 2900 strike. What position does the customer hold, and what does the assigned writer hold?

11.4 Which participant can receive a margin call — the option buyer or the option writer?

11.5 Volatility in the underlying futures increases sharply. What happens to call premiums and put premiums?

11.6 A trader buys 4 cotton options (50,000 lb each) at a premium of 2.15 cents per pound. What is the total cost and the maximum possible loss?

11.7 True or false: an out-of-the-money option has negative intrinsic value.

11.8 Which has more time value — an at-the-money option or a deeply in-the-money option, all else equal?

Answers

Chapter 12 — Option Strategies: Hedging, Speculating, Spreading

Everything here is generated by four positions and two breakeven formulas. Learn those, and every strategy question becomes a two-step derivation rather than something to remember.

12.1 The two breakeven formulas

$$\boxed{\text{Long call breakeven} = \text{strike} + \text{premium}}$$ $$\boxed{\text{Long put breakeven} = \text{strike} - \text{premium}}$$

The writer's breakeven is identical — the same number, viewed from the other side. Whatever the buyer needs to reach to break even is what the writer needs the market to stay short of.

The direction is intuitive if you check it rather than memorize it: a call buyer needs the market above the strike by enough to recover what they paid, so add the premium. A put buyer needs it below the strike by the premium, so subtract.

12.2 The four basic positions

Two structural facts the exam asks directly:

• The short call carries unlimited risk — the only position in the table that does. Prices can rise without bound.
• The buyer's loss is always capped at the premium, and the writer's gain is always capped at the premium. Gains and losses are mirror images across the two sides.

Worked example. A trader buys a December 470 corn call for \$0.22.

• Breakeven: $\$4.70 + \$0.22 = \$4.92$
• At expiration with futures at \$5.05: intrinsic $= \$0.35$; profit $= \$0.35 - \$0.22 = \$0.13$, or $\$0.13 \times 5{,}000 = \$650$.
• At expiration with futures at \$4.55: the call expires worthless; loss = the full premium, $\$0.22 \times 5{,}000 = \$1{,}100$.

The writer of that same call has the exact opposite results: \$650 loss in the first case, \$1,100 profit in the second.

12.3 Covered versus naked writing

Covered writing means the writer holds an offsetting position in the underlying — writing a call while long the underlying futures. The long futures position covers the obligation to deliver if assigned, so the risk is not unlimited. The trade-off: the writer collects the premium but caps their upside at the strike.

Naked (uncovered) writing means writing an option with no offsetting position. A naked short call carries theoretically unlimited risk and demands substantially more margin. Exams consistently frame naked call writing as the highest-risk option position, and that framing is correct.

12.4 Hedging with options

This is where options connect back to Chapters 7 and 8, and it is the most likely form for an option question to take.

The producer's floor: buy puts

A farmer holding a crop fears falling prices. Buying a put establishes a minimum selling price while leaving the upside open.

$$\text{Effective floor} = \text{strike} - \text{premium} \ (\pm \text{ basis})$$

Worked example. In June a farmer expects to sell soybeans in October. November futures are \$13.20. The farmer buys a November 1300 put for \$0.45.

• If prices collapse to \$11.80: the put is worth $\$13.00 - \$11.80 = \$1.20$ intrinsic. The farmer sells cash near \$11.80 and gains \$1.20 on the put, less the \$0.45 paid. Net ≈ $\$11.80 + \$1.20 - \$0.45 = \$12.55$ — the floor, which equals $\$13.00 - \$0.45$.
• If prices rally to \$14.60: the put expires worthless. The farmer sells cash at \$14.60, less the \$0.45 premium = \$14.15. The upside was kept, minus the cost of the insurance.

Compare that with a futures hedge at \$13.20, which would have produced roughly \$13.20 in both scenarios. The put costs \$0.45 and buys participation in the rally. That comparison — the price of optionality — is the core of the exam's option-hedging questions.

The buyer's ceiling: buy calls

A processor who will purchase later fears rising prices. Buying a call establishes a maximum purchase price while leaving the benefit of a decline open.

$$\text{Effective ceiling} = \text{strike} + \text{premium} \ (\pm \text{ basis})$$

The four hedging combinations

12.5 Speculative combinations

Long straddle — buy a call and a put at the same strike and expiration. Profits from a large move in either direction; loses if the market sits still. Maximum loss is the total of both premiums, and there are two breakevens:

$$\text{Upper} = \text{strike} + \text{total premium} \qquad \text{Lower} = \text{strike} - \text{total premium}$$

Short straddle — sell both. Profits if the market stays within the breakevens; carries unlimited risk on the upside.

Strangle — the same idea using different strikes, typically both out of the money. Cheaper than a straddle, and requires a larger move to become profitable.

Worked example. A trader buys a 2400 gold call for \$38 and a 2400 gold put for \$31. Total premium \$69 per ounce, or $\$69 \times 100 = \$6{,}900$ — the maximum loss. Breakevens are $\$2{,}400 + \$69 = \$2{,}469$ and $\$2{,}400 - \$69 = \$2{,}331$. The trader profits only if gold finishes outside that band.

12.6 Option spreads

A vertical spread buys one option and sells another of the same type and expiration at a different strike. It reduces both the cost and the maximum profit.

Both have limited profit and limited loss. The net premium paid is the maximum loss; the difference between the strikes minus that net premium is the maximum gain.

Worked example. Buy a 460 corn call at \$0.28, sell a 490 corn call at \$0.13. Net cost \$0.15 — the maximum loss, or \$750 on 5,000 bushels. Maximum gain: $(\$4.90 - \$4.60) - \$0.15 = \$0.15$, also \$750.

A horizontal (calendar) spread uses the same strike with different expirations, trading the difference in time decay.

12.7 Delta, in one paragraph

Delta measures how much an option's premium changes for a one-unit change in the underlying futures price. Calls have positive delta (roughly 0 to 1), puts negative (0 to −1). Deep in-the-money options have deltas approaching 1 in absolute value and behave nearly like the futures contract itself; far out-of-the-money options have deltas near zero. At-the-money options are near 0.50. Delta is also read as a rough probability of finishing in the money, and it is used to compute how many options are needed to hedge a given futures position.

Practice questions

12.1 A trader buys a July 640 wheat call for \$0.26. What is the breakeven, and what is the maximum loss on one 5,000-bushel contract?

12.2 A trader writes an uncovered December 2450 gold call for \$29. State maximum gain, maximum loss and breakeven.

12.3 A cattle producer wants to protect against falling prices but keep the benefit of a rally. What should the producer do?

12.4 A copper fabricator wants a maximum purchase price while retaining the benefit of a decline. What should the fabricator do?

12.5 A trader buys a 5200 index call for 42.00 and a 5200 index put for 37.00 (\$50 multiplier). Name the strategy, the maximum loss and both breakevens.

12.6 Which position carries theoretically unlimited risk: long call, long put, short put, or short call?

12.7 A soybean farmer writes calls against the growing crop, saying this hedges the position. Evaluate.

12.8 Buy a 300 sugar put at 0.42, sell a 280 sugar put at 0.19. Name the strategy, the maximum loss and the maximum gain in cents.

Answers

Chapter 13 — Interest Rate, Stock Index and Currency Futures

The financial contracts are not a separate scored category. They are tested through the other categories — as hedging questions, as speculation arithmetic, as terminology. What makes them worth their own chapter is that each has a quoting convention that must be memorized, and the exam's favourite trick is the inverse relationship between interest rates and prices.

13.1 The inverse relationship — learn this first

$$\boxed{\text{Interest rates } \uparrow \ \Longrightarrow \ \text{Debt instrument prices } \downarrow}$$

When rates rise, an existing bond paying a fixed coupon becomes less attractive, so its price falls. Everything about interest rate futures follows from this.

Who fears rising rates: anyone holding bonds (a dealer's inventory, a portfolio), and anyone who will borrow or issue debt later — a corporate treasurer planning a bond offering, a builder who will take a construction loan.

Who fears falling rates: anyone who will invest money later at prevailing rates — a pension fund expecting a contribution, an investor with a maturing CD to roll.

13.2 Treasury bond and note futures

A quote of 112-16 means $112 + \tfrac{16}{32} = 112.50\%$ of par, so the contract is worth $1.1250 \times \$100{,}000 = \$112{,}500$.

Worked example. A trader buys one T-bond contract at 108-08 and sells it at 110-24.

• 108-08 = 108 and 8/32. 110-24 = 110 and 24/32.
• The move is $2$ points and $16/32$, i.e. $2 + 0.5 = 2.5$ points.
• $2.5 \times \$1{,}000 = \$2{,}500$ profit.

Alternatively, count 32nds: from 108-08 to 110-24 is $(2 \times 32) + 16 = 80$ thirty-seconds, and $80 \times \$31.25 = \$2{,}500$. ✓ Both routes work; use whichever you can do without a slip.

13.3 Short-term rate futures: the IMM index

Short-term interest rate contracts — Treasury bills historically, and the Eurodollar and SOFR contracts that dominate today — are quoted on the IMM index:

$$\boxed{\text{IMM index price} = 100 - \text{the interest rate}}$$

An index of 94.75 implies a rate of 5.25%.

The \$25 comes straight from the arithmetic:

$$\$1{,}000{,}000 \times 0.0001 \times \tfrac{90}{360} = \$25$$

Because the index is $100 - \text{rate}$, the index moves inversely to rates, which conveniently makes it behave like a price: buy the contract if you expect rates to fall.

Worked example. A trader buys one contract at 94.75 and sells at 95.15.

• The move is $0.40$, which is 40 basis points.
• $40 \times \$25 = \$1{,}000$ profit.

The trader bought the index and it rose — meaning rates fell from 5.25% to 4.85%. Buying the index is a bet that rates decline.

13.4 Stock index futures

$$\text{Contract value} = \text{index level} \times \text{multiplier}$$

With the index at 5,240 and a \$50 multiplier, one contract represents $5{,}240 \times \$50 = \$262{,}000$ of equity exposure.

Hedging a portfolio: the beta-weighted ratio

$$\boxed{\text{Contracts} = \frac{\text{portfolio value}}{\text{index level} \times \text{multiplier}} \times \beta}$$

Beta measures how much the portfolio moves relative to the index. A beta of 1.0 moves with the market; 1.3 is a third more volatile; 0.7 is less.

Worked example. A manager holds a \$12,000,000 portfolio with a beta of 1.20. The index is 5,000 and the multiplier is \$50.

$$\frac{\$12{,}000{,}000}{5{,}000 \times \$50} \times 1.20 = \frac{\$12{,}000{,}000}{\$250{,}000} \times 1.20 = 48 \times 1.20 = 57.6 \approx \textbf{58 contracts}$$

The manager fears a decline while holding the stocks, so this is a short hedge — sell 58 contracts.

What the hedge does and does not remove

Selling index futures removes systematic risk — market-wide risk. It does not remove unsystematic risk, the risk specific to individual holdings. A hedged portfolio still suffers if one of its companies reports a disaster while the market is flat. This distinction is directly tested.

Index arbitrage / program trading. When the futures price diverges from fair value relative to the cash index, arbitrageurs buy the cheaper side and sell the richer, forcing convergence. This is the mechanism keeping index futures tied to the underlying basket.

13.5 Currency futures

The quoting convention is the whole battle: currency futures are quoted in U.S. dollars per unit of the foreign currency. A Japanese yen quote of 0.006850 means one yen costs \$0.006850.

Consequences:

• The contract rises when the foreign currency strengthens against the dollar.
• The contract falls when the dollar strengthens.
• Buying a currency future = long the foreign currency, short the dollar.

Hedging currency exposure

The logic mirrors Chapter 7 exactly: if you must buy the currency later, you fear it rising, so you buy futures. If you will receive the currency later, you fear it falling, so you sell futures.

Worked example. A U.S. manufacturer will pay €5,000,000 in six months. With a €125,000 contract size, the hedge is $5{,}000{,}000 / 125{,}000 = 40$ contracts, bought.

Interest rate parity, briefly. Forward and futures currency prices differ from spot by approximately the interest rate differential between the two countries. A currency with higher interest rates tends to trade at a forward discount, and vice versa. The exam wants recognition of the term, not a derivation.

13.6 Quoting conventions summary

Practice questions

13.1 A corporate treasurer will issue \$50 million of bonds in four months and fears rates will rise. Buy or sell T-bond futures?

13.2 A T-bond futures contract is quoted at 117-24. What is the dollar value of the contract?

13.3 A trader sells one T-bond contract at 115-16 and buys it back at 114-00. Compute the result.

13.4 A Eurodollar contract is quoted at 96.20. What interest rate does this imply?

13.5 A trader sells one short-term rate contract at 95.50 and covers at 95.10. Compute the result and state what happened to interest rates.

13.6 A manager holds a \$30,000,000 portfolio with a beta of 0.90 and wants to hedge. The index is 6,000 with a \$50 multiplier. How many contracts, and bought or sold?

13.7 Does selling stock index futures against a portfolio eliminate unsystematic risk?

13.8 A U.S. importer must pay 300,000,000 Japanese yen in three months. Should the importer buy or sell yen futures?

Answers

Chapter 14 — Regulatory Structure, the CEA, the CFTC, the NFA and Registration

Part 2 is 35 questions and is scored separately at 70%. You may miss ten. Chapters 14 through 17 are the whole of it, and they are the chapters candidates skim. Do not skim them.

14.1 The layers of regulation

Authority flows downward: Congress passes the CEA, the CFTC writes and enforces regulations under it, and the CFTC oversees the NFA and the exchanges as registered futures associations and self-regulatory organizations.

14.2 The Commodity Exchange Act

The CEA is the federal statute governing futures. Provisions the exam names directly:

14.3 The CFTC

The Commodity Futures Trading Commission is an independent federal agency created in 1974.

• Five Commissioners, appointed by the President with the advice and consent of the Senate.
• Five-year staggered terms.
• No more than three may be from the same political party.
• One Commissioner is designated Chairman by the President.

Its powers: writing regulations under the CEA, approving exchange rules and contract designations, registering intermediaries (in practice delegated to the NFA), conducting investigations, bringing administrative and civil enforcement actions, and hearing reparations claims from customers.

14.4 The NFA

The National Futures Association is the industry-wide self-regulatory organization for the U.S. futures industry, authorized by the CEA and overseen by the CFTC. It is funded by its members, not by the government.

What the NFA does:

• Registration — processes registration on the CFTC's behalf
• Membership — firms and individuals dealing with the public must be Members or Associates
• Rulemaking and enforcement — Compliance Rules, Business Conduct, promotional-material review
• Audits and examinations of member firms
• Arbitration of customer disputes
• Testing and proficiency requirements
• Ethics training requirements

The membership rule that gets tested: a firm required to register must be an NFA Member to conduct futures business with the public, and its APs must be Associates. Registration alone is not enough.

14.5 The registration categories

This table is the single most valuable thing in Part 2. Learn every row.

Guaranteed versus independent IBs

An independent IB must meet its own minimum capital requirements. A guaranteed IB instead enters a guarantee agreement with a single FCM, which assumes responsibility for the IB's obligations; in exchange the guaranteed IB has no separate capital requirement but may introduce accounts to that one FCM only.

14.6 How registration happens

Proficiency. An individual applying as an AP generally must pass the Series 3. It may be waived in limited circumstances — for example, where the individual passed it within the preceding two years, or has maintained continuous registration without a two-year lapse. A lapse of two years or more in registration generally requires re-examination.

Related NFA exams the test may name: Series 30 (branch manager), Series 31 (limited to managed futures fund products), Series 32 (limited futures — regulations), Series 34 (retail off-exchange forex).

14.7 Exemptions from registration

Exemptions are heavily tested because they define the boundary of the whole regime.

CTA exemptions (CEA §4m and CFTC Rule 4.14):

• Rule 4.14(a)(10) / §4m(1) — advised 15 or fewer persons in the past 12 months and does not hold itself out generally to the public as a CTA. Both conditions are required. Advertising publicly destroys the exemption no matter how few clients there are.
• Rule 4.14(a)(9) — the publisher exemption: advice is standardized and not tailored to the commodity interest positions or particular circumstances of individual clients — newsletters, websites, non-customized software. This exemption is self-executing; no notice filing is required.
• Persons whose advice is solely incidental to another business, and certain professionals (banks, registered investment advisers, lawyers, accountants) where the advice is incidental to their profession.

CPO exemptions (Rule 4.13) apply to small pools and to operators meeting defined conditions; unlike 4.14(a)(9), Rule 4.13 exemptions require a notice filing with the NFA.

Registered but relieved. Separately from exemption, Rule 4.7 provides relief from certain disclosure and reporting requirements for CTAs and CPOs dealing exclusively with Qualified Eligible Persons (QEPs) — sophisticated investors meeting portfolio and financial thresholds. A 4.7 claim requires a notice filing.

14.8 Statutory disqualification

Under CEA §8a, the CFTC may deny, suspend, condition or revoke registration. Grounds include:

• A felony conviction within the preceding ten years, especially one involving fraud, theft or financial misconduct
• A prior registration denial, suspension or revocation
• Injunctions or bars from a court or another financial regulator
• Certain misdemeanors involving embezzlement, forgery or securities/commodities violations
• Making a false or misleading statement in the registration application — a violation in itself, independent of what was concealed

Applicants must disclose disciplinary history. Concealing it is itself grounds for denial.

14.9 Supervision and ethics

NFA Compliance Rule 2-9 requires every Member to diligently supervise its employees and agents in all commodity-interest activities. The exam's framing: a firm is responsible for its APs' conduct, and a supervisory failure is an independent violation — the firm can be sanctioned for failure to supervise even when it did not participate in the underlying misconduct.

Ethics training is required for registrants, covering the CEA, CFTC and NFA rules, responsibilities to customers and to the market.

Practice questions

14.1 Which registration category may not accept customer funds?

14.2 How many CFTC Commissioners are there, who appoints them, and what is the limit on party composition?

14.3 A firm operates a fund that pools money from 40 investors to trade futures. What registration category applies?

14.4 A person advises 11 clients on futures trading for a fee and runs national advertising soliciting more clients. Are they exempt from CTA registration? Explain.

14.5 What form does a firm file to register, and what form does an individual file?

14.6 A guaranteed IB differs from an independent IB in what two respects?

14.7 Which body administers the Series 3 requirement, arbitrates customer disputes, and audits member firms — the CFTC or the NFA?

14.8 A registrant makes a false statement on the Form 8-R about a prior regulatory action. Is this a problem independent of the underlying action?

Answers

Chapter 15 — Customer Accounts, Disclosure and Required Documents

This chapter covers what must be given to a customer, what must be obtained from them, and what must be done with their money. The pattern is consistent enough to be a study aid: disclosure comes before trading, and customer money is never the firm's money.

15.1 The Risk Disclosure Statement

Before an FCM or IB may open a futures account for a customer, it must furnish a standardized Risk Disclosure Statement and obtain the customer's signed acknowledgment that it was received and understood.

Timing is the tested element: before the account is opened and before any trading occurs. Not with the first confirmation, not at the end of the first month.

What it discloses:

• The risk of loss in futures trading, which can be substantial
• That losses may exceed the amount deposited as margin
• The effect of leverage — small price moves producing large equity swings
• That stop orders may not limit losses to the intended amount
• That spread positions are not necessarily less risky than outright positions
• The possibility that positions cannot be liquidated under certain market conditions, such as a locked-limit market

A separate options disclosure is required for customers trading options on futures.

15.2 Opening the account

NFA Compliance Rule 2-30 requires Members to obtain customer information and to provide risk disclosure appropriate to that customer — the futures industry's analogue of a suitability rule. The obligation is heightened for customers who appear inexperienced relative to the risk. Note the framing carefully: the rule is fundamentally about disclosure calibrated to the customer, not about refusing business.

15.3 Segregation of customer funds

This is the most heavily tested single concept in Part 2, and its logic is absolute.

Under CEA §4d, an FCM must hold customer funds in segregated accounts, separate from the firm's own funds.

The rules, precisely:

• Customer funds may not be commingled with the FCM's own funds.
• Customer funds may not be used to finance the firm's business or the proprietary trading of the firm or its principals.
• Customer funds may not be used to margin or guarantee the trades of any other customer — one customer's money cannot cover another customer's deficit.
• Segregated funds must be held with a depository that acknowledges in writing that the funds belong to customers.
• The FCM may deposit its own funds into segregation as a cushion (a "residual interest"), but never the reverse.
• Funds for foreign futures are held under the parallel secured amount requirement rather than domestic segregation.

Why it exists: if the FCM fails, segregated customer funds are not available to the firm's general creditors, and customers have priority in the futures account class in bankruptcy.

15.4 Confirmations and statements

Every confirmation and statement must accurately reflect the transaction. Sending a statement that misrepresents prices, positions or account value is fraud, not a clerical matter.

15.5 Discretionary accounts revisited

From Chapter 5, in regulatory terms. A discretionary account requires:

1. Written power of attorney or trading authorization from the customer.
2. Written approval by a designated partner, officer or branch manager of the firm.
3. Frequent and systematic review by that supervisor, expressly for churning and for suitability.
4. Specific designation as discretionary in the firm's records, with orders marked accordingly.

Time and price discretion only — "buy one December corn, you pick the moment" — is not a discretionary account and requires no power of attorney. Authority over what and whether to trade does.

15.6 Bunched orders and allocation

Where an account manager places a single bunched order for multiple accounts, the allocation must be fair and equitable, and the allocation methodology must be established before the order is entered — not after the fills are known. Allocating good fills to favored accounts after the fact is a classic enforcement case, and the exam treats it as fraud.

15.7 Handling customer money and complaints

Prohibited absolutely:

• Accepting customer funds by an IB (they must go to the carrying FCM)
• Depositing customer funds into a personal or firm operating account
• Guaranteeing a customer against loss, or promising to make up losses
• Sharing in customer profits or losses without written authorization and the firm's approval, and, where required, proportionate to the person's own contribution

Customer complaints must be handled under the firm's supervisory procedures, forwarded to the appropriate supervisory personnel, and retained in the firm's records. A written complaint alleging misconduct is a supervisory event, not something an AP resolves privately with the customer.

15.8 Transfers, death and account changes

• Transfers between accounts require customer authorization; transfers may not be used to move losses or profits between customers.
• On the death or incapacity of a customer, the firm should be notified promptly, open orders cancelled, and no further trading permitted pending instructions from the legal representative. For a JTWROS account, the survivor takes the account; for tenants in common, the decedent's share passes to their estate.

Practice questions

15.1 When must the Risk Disclosure Statement be furnished to a customer?

15.2 True or false: the Risk Disclosure Statement states that spread positions may not be less risky than outright positions.

15.3 An FCM temporarily uses funds from Customer A's segregated account to cover a margin deficit in Customer B's account. Permissible?

15.4 May an FCM deposit its own funds into the customer segregated account?

15.5 An AP promises a hesitant prospect that the firm will reimburse any losses in the first month. Evaluate.

15.6 By when must a customer receive confirmation of a trade?

15.7 A CTA places a bunched order for twelve accounts and decides the allocation after seeing the fills, giving the best prices to the largest accounts. Evaluate.

15.8 What two documents must a corporation provide to open a futures account?

Answers

Chapter 16 — Sales Practices, Prohibited Conduct and Promotional Material

If Part 2 has a theme, it is this chapter. Most regulation questions are scenario questions: an AP does something, and you must decide whether it is permitted. The scenarios repeat, and they are listed here.

16.1 The antifraud provisions

CEA §4b prohibits cheating, defrauding, or willfully deceiving any person in connection with futures orders or transactions, and prohibits making false reports or statements to customers.

CEA §4o applies the same prohibition specifically to CTAs and CPOs, and it reaches exempt advisors too — an exemption from registration is never an exemption from fraud liability.

NFA Compliance Rule 2-2 prohibits fraud and deceit by Members. NFA Compliance Rule 2-4 requires Members to observe high standards of commercial honor and just and equitable principles of trade — the catch-all under which conduct that is sleazy but not specifically enumerated is charged.

16.2 The prohibited practices list

Learn each term with a one-sentence description. The exam asks by name.

Churning — the three elements

A churning claim requires all three:

1. Control of the account by the broker (actual or de facto — a customer who always says yes can still be a controlled account),
2. Excessive trading relative to the customer's objectives and resources, and
3. Intent to generate commissions.

Excessive activity alone is not churning if the customer directs it. This nuance is testable.

16.3 Communications with the public

Every statement to a customer or prospect must be truthful, balanced and not misleading.

Specifically prohibited:

• Guaranteeing profits or stating or implying that loss is unlikely or impossible
• Presenting futures trading as low risk or suitable for everyone
• Statements of past performance that are not accurate, complete and verifiable
• Discussing profit potential without a balanced discussion of the risk of loss
• Using the CFTC's or NFA's name to imply approval or endorsement of the firm or its trading — registration is never an endorsement
• Predicting specific price levels or profits

16.4 NFA Compliance Rule 2-29 — promotional material

Promotional material is broadly defined: any written or electronic publication, advertisement, website, social media post, email, radio or television commercial, seminar presentation, or standardized sales presentation used to solicit business.

The core requirements:

1. No misleading content. The ultimate test under Rule 2-29(b) is whether the overall impression of the material is misleading or likely to deceive — not whether each sentence is literally defensible in isolation.
2. Balanced risk discussion. Any discussion of profit potential must be accompanied by an equally prominent discussion of the risk of loss.
3. Supervisory review. Promotional material must be reviewed and approved by a designated supervisor before first use.
4. Recordkeeping. Copies of promotional material, and documentation supporting any performance claims, must be retained.

Hypothetical performance results

Rule 2-29(c), with Interpretive Notice 9025, governs the use of hypothetical performance — results from simulated or backtested trading rather than actual trades. The requirements:

• A prescribed, expanded disclaimer must accompany the results.
• All material assumptions used to prepare the results must be described.
• The Member must be able to demonstrate to the NFA the basis for the results and must keep the records to document how they were calculated.
• Where the Member has actual trading results, those must be included alongside the hypothetical ones — hypothetical results may not be presented in isolation as if they were a track record.
• Relief from certain of these requirements exists for material directed exclusively to Qualified Eligible Persons under Rule 4.7.

The prescribed hypothetical-performance disclaimer language, which the exam may quote, turns on these points: hypothetical results have inherent limitations; no representation is made that any account will achieve similar profits or losses; there are frequently sharp differences between hypothetical and actual results; hypothetical results are prepared with the benefit of hindsight; and hypothetical trading does not involve financial risk, so no hypothetical record can account for the impact of financial risk in actual trading.

16.5 Telemarketing and solicitation

• Do-not-call lists must be maintained and honored; a person who asks not to be called again must be recorded and not called.
• Calls are restricted to reasonable hours.
• The caller must promptly identify themselves, their firm, and the purpose of the call.
• Firms employing persons with certain disciplinary histories are subject to enhanced supervisory and recordkeeping requirements, including taping of telephone solicitations in defined circumstances.

16.6 Supervision

NFA Compliance Rule 2-9 requires every Member to diligently supervise its employees and agents in all commodity-interest activities. In practice this means written procedures, designated supervisors, review of accounts and communications, and follow-up on red flags.

Failure to supervise is an independent violation. A firm can be disciplined for inadequate supervision even where it neither knew of nor participated in the underlying misconduct. If a question describes a firm that ignored obvious warning signs, the answer involves a supervisory failure regardless of what else is charged.

Practice questions

16.1 An AP tells a prospect: "Based on our system's record, you can expect to double your money this year, and I'll personally cover any losses in the first quarter." Identify every violation.

16.2 A broker with de facto control of an account trades it heavily, generating large commissions and mediocre results. What is this called, and what must be shown?

16.3 A firm's advertisement says: "Registered with the CFTC — your assurance of professional competence." Evaluate.

16.4 Define bucketing.

16.5 A broker learns a customer is about to place a large buy order and buys for their own account first. What is this called?

16.6 A CTA publishes a backtested track record with a one-line disclaimer and no actual trading results, though the CTA has traded actual accounts for two years. Evaluate under Rule 2-29.

16.7 True or false: an exemption from CTA registration also exempts the adviser from the antifraud provisions.

16.8 Must promotional material be reviewed before use, or is post-use review acceptable?

Answers

Chapter 17 — CPOs, CTAs, Recordkeeping, Position Limits and Dispute Resolution

The last of the regulations block. Three unrelated topics share this chapter because each is worth a handful of questions and each is mostly a matter of knowing specific numbers.

17.1 CTAs and CPOs

A single person can be both. Someone who operates a fund and also directs separately managed accounts is a CPO for the fund and a CTA for the accounts.

The Disclosure Document

A registered CTA or CPO must deliver a Disclosure Document to each prospective client or pool participant. The requirements the exam tests:

• It must be delivered no later than the time the advisory agreement is entered into or funds are solicited — before the client commits.
• It must be filed with the NFA and accepted before it is used to solicit.
• It may not be more than 12 months old; it must be updated at least annually, and promptly whenever it becomes materially inaccurate.
• The client must acknowledge receipt.

Contents include: the business background of the operator and its principals, the trading program and strategy, all fees and expenses, actual performance history (or a statement that there is none), conflicts of interest, risk factors, and any material administrative, civil or criminal actions within the preceding five years.

Rule 4.7 relieves CTAs and CPOs dealing exclusively with Qualified Eligible Persons from certain disclosure and reporting requirements, on a notice filing.

Pool reporting

• Account statements to participants: monthly for pools above the applicable net-asset threshold, and at least quarterly otherwise.
• Annual report: distributed to participants and filed with the NFA within 90 days of the pool's fiscal year end, certified by an independent public accountant.

Pool funds must be maintained in the pool's own name and may not be commingled with the operator's assets or with any other pool.

17.2 Recordkeeping

CFTC Regulation 1.31 is the general rule, and its numbers are asked directly:

$$\boxed{\text{Records must be kept for } \textbf{5 years}, \text{ readily accessible for the first } \textbf{2 years}}$$

Records must be produced to the CFTC, the NFA or the Department of Justice on request.

Records that must be kept include: account documents and agreements, signed Risk Disclosure acknowledgments, order tickets with time of entry and execution, confirmations and monthly statements, general ledger and financial records, promotional material and the documentation supporting any performance claims, customer complaints, and Disclosure Documents.

Order tickets must record the account, the order terms, and the time of receipt and time of execution. Time-stamping is what makes front-running and trading-ahead detectable, which is why the exam treats it as a substantive requirement rather than clerical detail.

17.3 Position limits and reporting

Speculative position limits cap the number of contracts a speculator may hold, to prevent any single participant from dominating a market or manipulating prices. They are established by the CFTC and the exchanges.

Bona fide hedgers may apply for exemptions from speculative position limits, because their positions offset genuine cash-market exposure. Recall from Chapter 3 that hedgers also receive lower margin requirements — the two benefits travel together and are frequently offered as paired answer choices.

Reportable positions. Traders holding positions above defined levels must be reported to the CFTC by their carrying firms, and large traders are subject to the large trader reporting system. Reporting levels are lower than position limits: you can be reportable long before you are near a limit.

The distinction the exam draws: a position limit is a cap on what you may hold; a reporting level merely triggers disclosure. Being reportable is not a violation of anything.

17.4 Dispute resolution

Three forums, and the exam tests which is which.

Points that get tested:

• Arbitration decisions are generally final and binding, with very limited grounds for appeal.
• A customer generally cannot pursue the same claim in two forums simultaneously — electing one forecloses the others.
• Reparations is available against a registrant and requires a violation of the CEA or CFTC regulations; it is not a general-purpose contract forum.
• Both the NFA and reparations routes carry a two-year filing window. If a question gives you a claim brought three years later, it is time-barred in both.

17.5 Enforcement and sanctions

NFA proceedings run through its Business Conduct Committee. Sanctions include censure, fines, suspension, expulsion from membership, and bars from association with Members. Loss of NFA membership effectively ends the ability to do futures business with the public.

CFTC may bring administrative proceedings and civil actions seeking cease-and-desist orders, civil monetary penalties, trading prohibitions, restitution/disgorgement, and registration revocation, suspension or denial. The Department of Justice prosecutes criminal violations.

Bankruptcy of an FCM. Customer property in the futures account class is distributed to customers pro rata ahead of the firm's general creditors — the practical payoff of the segregation requirement in Chapter 15.

17.6 The numbers to memorize

Practice questions

17.1 How long must records be retained, and for how long must they be readily accessible?

17.2 A CTA gives a prospective client a Disclosure Document dated 16 months earlier. Evaluate.

17.3 When must a Disclosure Document be delivered relative to the advisory agreement?

17.4 Within how many days of a pool's fiscal year end must the annual report be distributed, and must it be certified?

17.5 A customer wants to bring a claim against a registered FCM for violating CFTC regulations three years after the events. What forums are available?

17.6 May a bona fide hedger exceed speculative position limits?

17.7 A trader's position reaches a reportable level. Has the trader violated anything?

17.8 A CPO deposits pool funds into an account holding the operator's own working capital. Evaluate.

Answers

Appendix A — The Formula Sheet

Every calculation the Series 3 can ask, in one place. If you can reproduce this page from memory on scratch paper in the first two minutes of the exam, you have removed most of the arithmetic risk from the day.

Contract value and P&L

Sign discipline: find the size of the move, decide whether it was favorable or unfavorable to the position's direction, then apply the sign. Never carry a negative through the multiplication.

Margin

Restore to initial, not maintenance. Maintenance is only the trigger.

Basis and hedging

Short hedgers want it strong. Strengthening = more positive / less negative.

Options

Financial contracts

Rates up → prices down. Fear rising rates → sell. Fear falling rates → buy.

Carrying charges and spreads

Regulatory numbers

Contract sizes worth knowing

Verify current specifications with the exchange — sizes and tick values are periodically revised, and the exam is written against the specifications current at the time it was drafted. The method in this appendix never changes; the numbers occasionally do.

Appendix B — The Exam-Day Playbook

B.1 The structure, one more time

Do the arithmetic on what 70% means, because it changes how you should feel about each part:

Part 2 is where the exam is lost. Ten misses out of thirty-five is a thin margin, and every one of those questions comes from Chapters 14–17 — the material that reads like a rulebook and is easiest to under-prepare. A candidate at 95% on Part 1 and 68% on Part 2 fails the whole exam and retakes both parts.

If your mock-exam scores are lopsided, the correct response is to stop studying the strong part entirely. There is no credit for a 95 on Part 1.

B.2 Timing

150 minutes for 125 questions is 72 seconds per question. That is generous for this exam — most questions are recall or two-step arithmetic. The realistic plan:

Never leave a question blank. There is no penalty for a wrong answer, so a blank is strictly worse than a guess.

The brain dump is worth the three minutes. Basis direction, the margin-call rule, breakeven formulas, the 32nds and basis-point values, and the strengthening/weakening table are all things you would rather read off paper than reconstruct under time pressure in question 94.

B.3 How to read a question

Identify the side first. For any P&L question, establish long or short before computing anything. Most arithmetic errors on this exam are sign errors, not calculation errors.

Translate rates into prices. Any interest-rate question should immediately become a price question. "Fears rising rates" → "fears falling prices" → "sells."

Translate the hedger into a direction. "Does this person suffer if prices rise or fall?" Owns it → short hedge. Will buy it → long hedge. Every hedging question is that question in costume.

Watch for "except" and "not." Regulations questions especially like "all of the following are prohibited EXCEPT." Read the stem twice when a negative appears.

Distrust absolutes in market questions, trust them in regulatory ones. In Part 1, answers containing "always" and "never" are often wrong — markets have exceptions. In Part 2, many rules genuinely are absolute: customer funds may never be used to margin another customer's trades; an IB may never accept customer funds; a registrant may never guarantee against loss. Do not talk yourself out of a correct absolute in the regulations.

B.4 Guessing strategy

When you genuinely do not know:

1. Eliminate answers that contradict a core principle. Anything describing margin as a loan or down payment, options as obligating the buyer, or registration as an endorsement is wrong on its face.
2. Prefer the answer that protects the customer. In regulatory scenarios, the more customer-protective answer is right far more often than not — disclosure over silence, supervision over autonomy, segregation over convenience.
3. Prefer the more complete answer in exemption questions. The 15-or-fewer CTA exemption requires both conditions; an option that gives only one is a designed distractor.
4. Extreme is often wrong in market questions. "Unlimited" is correct only for the short futures position, the long call's gain, and the short call's loss. Everywhere else, it is a distractor.

B.5 The ten items most likely to be missed

Learn these cold, because each one is a designed trap:

1. Restore to initial margin, not maintenance. Maintenance is only the trigger.
2. Basis = Cash − Futures. Reversing it inverts every conclusion.
3. Short hedgers want a strengthening basis; long hedgers want a weakening basis.
4. A stop becomes a market order — it guarantees no price and may not execute at all in a locked-limit market.
5. Buy stops go above the market, buy MITs go below. Stops are placed against you.
6. The option buyer never posts margin and can never receive a margin call.
7. Rates up → bond prices down. Fear rising rates → sell futures.
8. Rising open interest confirms the trend; falling open interest means liquidation. A rally on falling open interest is short covering, and is weak.
9. An IB may never accept customer funds, and customer funds may never margin another customer's trades.
10. The CTA exemption needs both conditions — fifteen or fewer clients and no public holding out.

B.6 The week before

• Take full, timed mock exams — the study app's Mock Exam mode enforces the 85/35 split and scores each part separately at 70%. Take at least three.
• Do not schedule until you are consistently at 80%+ on both parts. The gap between 70 and 80 is your margin for exam-day nerves and an unlucky question set.
• Re-read Chapters 14–17 the day before. They decay fastest and they are the binding constraint.
• Rebuild Appendix A from memory on blank paper. If any line is shaky, that is your last study session.

B.7 After you pass

Passing the Series 3 is one requirement among several. Registration also requires Form 7-R (the firm), Form 8-R (each individual principal and AP), fingerprint cards, a fitness review, and NFA membership — a firm must be an NFA Member to conduct futures business with the public, and individuals must be Associates. Ongoing obligations include the annual registration update, the member questionnaire, dues, and ethics training.

There is also a shelf life on the exam itself: a lapse in registration of two years or more generally requires re-examination. Confirm current requirements, fees and deadlines directly with the NFA and the CFTC — this book prepares you for an examination, and is not a substitute for the current rulebooks or for counsel.

Appendix C — Glossary

The terms most likely to appear as a direct definition question, or to be the difference between understanding a stem and guessing at it. These are the same terms loaded into the study app's flashcard decks.

Market structure and participants

Positions and market data

Margin

Orders

Hedging and basis

Spreads

Options

Financial contracts

Delivery

Regulation