Lumber futures can be defined as an option or obligation to buy or sell a specified quantity of lumber at a specific price at a pre-determined date in the future. A futures contract is a standardised derivative contract that gets its value from an underlying asset. This contract is between two parties who intend to buy or sell a specified amount of product at a specific time in the future. Lumber futures are traded at the CME (Chicago Mercantile Exchange).
CME is the first exchange that offers price protection to the forest products industry. Typically, random length lumber futures contracts or LB trade in 2x4 random lengths from 8 to 20 feet. The deliverable species primarily includes the Western Spruce-Pine-Fir (SPF), with mills in the states of Idaho, Oregon, Nevada, Washington, Wyoming, Alberta, Montana, California, or the Canadian provinces of British Columbia.
If we take a look at recent numbers, lumber prices have reacted to demand and supply imbalances with extreme and frequent changes. There have been constraints seen in domestic lumber supplies due to several natural and unnatural reasons as well. From the demand side, the interest rate policies and economic conditions have resulted in the prices of housing starts to reach record highs.
Companies that process, market, use, or produce lumber or forest products can reduce the risk of acquiring inventory and hedge their exposure to risk by trading in lumber futures. Traders might want to sell or buy LB to understand if lumber prices will fall or rise in the future. Understanding the risks and benefits associated with the trading, thus, becomes crucial before making the investment decision.
Lumber futures provide efficient use of trading capital by providing companies with the ability to trade with greater leverage. Having said that, trading in lumber futures also involves the risk of losses that exceed the invested amount and thus is a subject one should consider very carefully.
The most vital distinction between other financial instruments and futures trading is the use of leverage. When a futures contract is initiated, the buyer isn’t obligated to pay the entire amount, and instead can pay only the initial margin of the total value (a small upfront payment).
Since the value of futures is based on other derivatives, it has no inherent value. The contract is drawn solely for a fixed period and comes with an expiration date. This is why monitoring the historical market of the commodity, in this case, lumber, and the timing is crucial while dealing with futures.
To sum it up, the lumber futures market can be an excellent way to leverage trading & maximise gains for both the buyer and the seller. The buyer profits from the rise in the price, and the seller profits from the drop in the price of the commodity, at the predetermined date.