What it means
Futures are contracts to buy or sell an asset, such as oil, wheat, gold or a stock index, at a set price on a future date. They are traded with leverage, meaning that a small deposit controls a large amount of the underlying asset, and losses as well as gains are magnified.
Because of this, regulators require people who deal with the public in futures to pass a proficiency test. The Series 3 exam covers how futures markets work, the mechanics of margin and settlement, hedging and speculation, order types, and the ethical and legal rules of the industry.
A passing score is one of the conditions for being registered as an associated person of certain firms, such as futures commission merchants, introducing brokers and commodity trading advisors. The qualification matters to non-futures businesses too.
A company that hedges fuel, grain or currency may use a broker whose staff hold this registration, and the registration gives some assurance that the person has been tested on risk and customer protection. Corporate treasury teams often ask brokers about the credentials of their account managers.
Exemptions and alternatives exist. For example, people who have passed it recently or who are in certain registered roles may not need to retake it, and a related exam exists for those whose futures activity is limited to managed funds.
The NFA sets and updates the requirements, so the current rules should always be checked. Understanding the exam helps non-specialists interpret the market.
When a broker explains that a position needs margin, or that a hedge may produce a gain on the futures side offset by a loss on the physical side, the language derives from the material that this exam tests. Another point worth knowing is that futures settle through a clearing house, which stands between buyer and seller and requires daily margin adjustments.
This process, known as marking to market, means gains and losses are paid in cash every day rather than at the end of the contract. For corporate treasurers, daily cash movements are the biggest practical difference from a bank forward contract.
In practice
Real-world examples.
Example
An airline treasury team opens a futures hedging account for jet fuel. The treasurer asks the broker whether the account manager holds the proper registration. She files the confirmation with the hedging policy documents.
Example
A commodity trading advisor recruits a new analyst who will contact clients about managed accounts. The firm schedules the exam in the analyst's first month and delays client contact until the registration is complete. The delay is documented in the firm's compliance file.
Example
A farm cooperative uses futures to lock in wheat prices ahead of harvest. Its finance manager studies how margin calls work after hearing that a price spike required an extra $60,000 deposit within a day. She sets aside a cash reserve for such calls.
Formula
Calculation
Notional value = futures price x contract size x number of contracts
Initial margin = notional value x margin percentage
Suppose a manufacturer buys 5 crude oil futures contracts, each covering 1,000 barrels, at $80 a barrel. Notional value = 80 x 1,000 x 5 = $400,000. If the broker requires an assumed initial margin of 5%, the deposit is 400,000 x 5% = $20,000. A $2 per barrel fall in price would produce a loss of 2 x 1,000 x 5 = $10,000, which is half of the deposit, showing how leverage magnifies movements.Case study
Seen in the real world.
Prairie Grain Cooperative is an illustrative, fictional business that hedged its harvest with futures but assumed margin was a one-time deposit. A sudden price rise triggered a call for $120,000 of extra margin within twenty-four hours.
The cooperative's finance manager had not planned for this cash need, and she borrowed on a short-term line at a higher rate. Afterwards she asked its broker, whose staff held the proper futures registrations, to explain how variation margin works.
The cooperative then added a liquidity buffer of $250,000 to its hedging policy. The illustrative lesson is that hedging reduces price risk but creates cash-flow risk, which must be planned for. She also now presents a monthly summary of open futures positions and margin balances to the finance committee.
Watch out
Common mistakes.
- Assuming a futures margin deposit is a fee, when it is a performance bond that can be called upon again if prices move against you.
- Believing a hedge removes all risk, when it can produce cash demands before the offsetting gain on the physical asset is realised.
- Assuming every person who discusses futures holds the exam, when exemptions and alternatives apply in some roles.
Questions
People also ask.
Who sets the Series 3 requirement?
The National Futures Association, working under the oversight of the Commodity Futures Trading Commission, sets proficiency requirements for futures professionals.
Is Series 3 only for traders?
No, it also applies to many people who solicit or advise customers on futures, such as associated persons of brokers and advisors.
Does a company hedging with futures need the exam itself?
Generally no, a company trading for its own account does not need the registration, though the intermediaries it uses usually do.
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