Series 3 Test Tips

Here are some great series 3 test tips to master for your series 3 exam. Students need to master the economic factors that can impact the prices of commodities one of the important factors is supply and demand elasticity.

The supply and demand for any given commodity may be elastic or inelastic based on changes in the price of the commodity. This is known as price elasticity. If the price of a commodity increases and the demand for the commodity remains the same the demand for the commodity is said to be inelastic. That is because the change in the price of the commodity did not result in a change in the amount of the commodity purchased. Alternatively, if an increase in the price of the commodity resulted in lower demand for the commodity, the demand for that commodity would be said to be elastic. Conversely, If the price of a commodity increased and it attracted new producers, the supply for that commodity would be said to be elastic as the change in price resulted in a change in the supply. If an increase in price did not result in increased supply, the supply would be said to be inelastic. The cost of establishing production or to entering a market will greatly impact the elasticity of the supply for a given commodity. The greater the costs and barriers to entry the more inelastic the supply for the commodity will be. The supply for agricultural products tends to be elastic as farmers adjust production relatively quickly to a change in the price for any given commodity.

Not all customers are going to deposit cash to meet the margin call for commodities. There are a number of other forms of deposit that can be used to satisfy the margin requirements.

Some FCMs will allow a customer to meet a margin deposit in forms other than in cash. For example an investor may maintain a letter of credit from a bank with the FCM. An investor may also deposit Treasury bills, notes or bonds as well as stocks, ETFs and corporate bonds. These alternative margin deposits will not have the entire market value of the security credited towards meeting the margin requirement. Stocks and ETFs will be subject to a haircut of 30 percent. If a customer were to deposit $100,000 with of fully paid for stock, the FCM would value that at $70,000 for margin purposes. While gold and corporate bonds will be subject to a 15 percent and 20 percent haircut on the market value respectively. Take note a letter of credit will not be subject to a haircut and the full amount of the letter will be available for margin purposes.

Compliance issues are heavily tested on the series 3 exam. When speaking or making presentations to customers Associated Persons must balance how the risks and rewards are disclosed.

Particular issues can arise when trying to achieve a balance in the presentation of information verbally. Presentations made over the phone or during seminars should try to balance the amount of time dedicated to explaining the opportunities and risks of investing in futures. Should an AP discuss the opportunities of investing in futures with a potential client for 30 minutes during a phone call, the AP must spend a reasonable amount of time discussing the potential risks. If the AP does not spend a reasonable amount time going over the risks of investing in futures and merely offers to email or send the risk disclosures this would not be considered reasonable and balanced. This same standard is in place for live seminars. Streaming or other videos used to promote futures business must also balance the amount of time spent detailing the risks involved in futures investing. Most video promotions will add a canned risk disclosure at the end of the presentation but this alone may not be enough to meet NFA standards. Infomercials and appearances where the member pays for the time on TV or radio must make specific disclosures at the opening and closing of the presentation to make sure the audience knows that this is a paid promotion made by the member. Legitimate interviews that are under the control or direction of the TV, radio station or website are still deemed to be promotional activities and must try to balance the risks of futures during the interview. However, these interviews do not require the same opening and closing disclosures of an infomercial. Special care must be used when discussing the risks of trading options on futures. It is considered to be misleading if the speaker or promotional material simply states that trading options on futures has limited risk. Only certain long option positions have limited risk equal to the amount of the premium paid. Any mention of limited risk in option trading must clearly state this fact.

The series 3 exam will require you to master option and commodity future spreads one particular spread involves futures on Treasury securities.

Spreading Treasury Futures A popular spread using Treasury futures is an inter-maturity spread. This spread involves establishing a position in T-bill futures while simultaneously establishing an opposite position in T bond futures. When establishing a spread of this type it is important to remember that the contact size for the underlying instruments vary greatly. The T-bill contract covers a par value of $1 million, while the T bond contract covers a par value of $100,000. An investor who is looking to establish a dollar weighted spread must establish the spread as a 1:10 spread. That is to say that for each T-bill contract position opened the investor would have to establish an opposite position in 10 T-bond futures. As interest rates change the price of the longer term treasury bond will move more in price than the T-bill. Therefore if an investor felt interest rates were going to fall the investor would sell bills and buy bonds. If the investor felt that rates were going to increase the investor would buy bills and sell bonds. An investor could also establish an inter-maturity spread as a hedge using bill and bond futures based on the contract size and the maturity. Because the T-bill contract covers a par value of $1 million based on a 3 month treasury bill, and the bond contract is based on a par value of $100,000, the hedge must be established at a 4:1 ratio based on the par value. For every 2 bill contracts established the investor must establish an offsetting position in 5 T-bond contracts. This would result in a bill position based on $2,000,000 in par value against a bond position of $500,000. Once established if both long and short term rates change by the same amount the change in the aggregate price of each position should be approximately equal.

Good luck on your Series 3 Exam

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