can buy the futures at a good discount. Some stock feeders will buy corn futures if corn is scarce and the futures at a good discount. The trouble in 1921 May wheat at Chicago was due to the desire of A. C. Field, an exporter, who had sold wheat for forward delivery abroad, to obtain wheat by way of the futures to meet his contracts. It was a costly thing for the speculators that they were so ready to believe the long interest did not want the actual wheat delivered.

Elevators, as has already been noted, will always take grain on delivery when they can carry it profitably under hedge from one option to another.

Section 13. Services and costs of hedging.

STABILIZATION OF PROFITS.-That the practice of hedging promotes stability of turn-over profits or margins, even where the futures market is far from perfect, may be considered statistically inevitable and obvious. A series of variables obtained by combining the corresponding items of two unrelated series of variables will be less variable than the original series. If the variations of the two original series that are thus combined are inversely correlated, so that when one is greater the other is less, the combined series is bound to be decidedly smooth as compared with either of its constituents. It is certain that cash and future prices do in general move up and down together, and therefore that a future sale (a hedge) will almost always show a loss when cash prices move up considerably and present the merchant with an unexpected gain on the cash grain taken by itself. Profits for any considerable period are inevitably stabilized by hedging.

In Volume IV 30 of this report certain average margins for various classes of grain dealers obtained from their books of account are shown. Results with and without hedges are separately computed. The results obtained are much less scattered or spread out when modified by the hedging practice.

Handling margins increased very markedly during the war and continued very high for some time thereafter. They were high not merely in terms of cents but also rather high relatively to the price of grain. This general situation may be attributed largely to the fact that in practically all lines of business at that time there was a "sellers' market." Buyers competed for supplies and sellers did not have to go out after business. This situation doubtless increased handling margins in grain as in other lines.

The situation at this time was affected not merely by the absence of a hedging market for wheat but also by the unsatisfactory character of hedging facilities in corn and oats, due to very large discounts on the futures. How this sort of a situation affects the hedger is shown elsewhere.32 It is summarized in the second following subsection.

HEDGING IN THE SERVICE OF COMPETITION.-The opportunity to hedge enables the smaller dealer, or at least the dealer with limited financial resources in proportion to the scale of his operations, to stay in the

30 Chap. III, p. 57.

See data in Vol. IV, pp. 16, 54.

32 Chap. VI, sec. 3.

competitive strength-and especially if sometimes, as believed, it is a factor important enough to enable its drive out competitors with greater operating efficiency resources then hedging facilities promote efficient com needs no argument to convince that efficient competition means of keeping down handling margins.

The hedging facility, it is important to note, helps t grated, as well as the less wealthy, grain handler.

THE PRICE PAID FOR THE HEDGING SERVICE. It is too eas that the cost of the hedge consists of the commission p cuting the future contracts-that is (at Chicago), onecent per bushel, or $12.50 for a 5,000-bushel lot, sold and $2.50 for a 1,000-bushel lot. The member rate is one-ha Prior to 1919 the nonmember rate for 5,000-bushel lots wa To the one-fourth cent per bushel should be added sor the difference between bid and asked prices, or the price a rather urgent seller "at the market," and that paid by urgent buyer. On the Chicago market this doubtless a than one-eighth of a cent on a transaction. But the he this situation twice on every hedge. He, as the seller, is more urgent than the buyer, and in closing his hedge he, a is presumably again the more urgent party to the con future transactions are controlled as to time and quan cash-grain trades, while the speculator's participation is matter of choice. The group of perhaps two hundred Chicago is largely supported out of the difference betwe asked prices, and their competition tends to keep down th in the cost of the hedge. Perhaps the combined burder hedger on account of this element in cost is less than onecent per bushel.

Something more should be added to the costs of hedging for the tendency of the futures to run below a true parit quality of the grain that will be delivered on future con the associated tendency of this discount to close up more the maturity of the option approaches. There is no wa mating the average amount of this element in the cost o more especially as it depends on the length of time during hedge trade remains open, as well as varying greatly fro year and otherwise.

The above elements of cost are costs per bushel. Whil these costs tend to be reduced by a quick turnover, the gr per bushel tend by the same practice to be smaller, so that ing cost ratio is probably not less. In relation to a give of holdings of grain, the rapidity of turnover tends to in cost ratio.

ts possessor ey but smaller mpetition. It on is the best

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CHAPTER III

SCALPING AND SPREADING

Section 1. Nature and effect of pit scalping.

RELATION OF PIT SCALPING TO HEDGING.-Hedging as practiced by terminal grain dealers and shippers often involves the placing of very large orders in futures for prompt execution. Thoroughly serviceable hedging involves the ability to place market orders at substantially the current quotation on the future. The natural tendency of a selling order, however, is to put the market down, and of a buying order to put it up. In either case the trader, in putting out large lots in a narrow market, may suffer a considerable disadvantage in the price to be paid or received. The hedger, of course, prefers to place his hedges where he does not thus put the market against himself.

Readiness to absorb such trades under any circumstances can be best secured by the presence of many men willing to trade on their own account for a narrow margin of profit and, of course, with a quick turnover.1 The competition of such traders tends to keep them from getting more than a narrow margin. Before prices were advanced by the war and other causes a large proportion of transactions in wheat futures on the Chicago Board of Trade were at "split " prices—that is, in sixteenths of a cent-and in a comparatively stable market the scalper may be willing to trade on this basis.

The need of a broad and continuous market in closing a hedge, or a speculative contract, is equally great with the need in opening such a contract.

The term "scalper" is used in various connections as referring to a type of middleman who seeks small profits from quick and frequent purchase and resale in the same market. The profitableness of the operation depends, in so far as scalping in futures is concerned, on ability to take advantage of technical conditions and developments affecting the coincidence of supply and demand. In general, the scalper does nothing to forward the commodity between producer and consumer and in no way seeks to prepare it for consumption.

In the grain trade there are car-lot scalpers of cash grain and pit scalpers dealing in futures.

DIFFERENCE BETWEEN SCALPERS AND SPECULATORS.-According to common usage at Chicago, pit scalpers and speculators are distinct classes, the former attending only to technical conditions and temporary market fluctuations, while the latter have in view longer price swings and fundamental demand and supply conditions. The one is concerned only with the effects on the market of temporary

1 It is noteworthy that when an exchange attempts to start a new futures market it is the practice, it appears, for the firms interested in the enterprise to pledge themselves to do a specified minimum quantity of trading in the new market each day.

2 See Vol. III of this report, Ch. IX.

to be even as to quantities bought and sold at the close of day and is reluctant to carry a trade over night.

The scalper looks for a profit of but a fraction of a ce seldom stick for a loss of more than a cent a bushel. T margin is indicated rather liberally when it is said t trader typically protects on a one-fourth cent loss an profit on a one-half cent gain. One scalper refers to cated "to buy at an eighth and sell at a quarter." The s tinually changes his position. He buys when the " hedging sales" tends to weaken the market, expecting will rebound as soon as the pressure is off. He intends t outsiders bent on buying are momentarily swinging unduly upward. The professional scalper is present The speculator, even though a member and with the rig for himself, usually has his orders executed by others.

There is no reason why a pit scalper should not on oc speculator for the long turn, unless it be lack of financial The latter is not always effective as a preventive of s however, even among men in the grain trade. Some pi also, are men of considerable pecuniary means. The ch why pit scalpers do not often thus speculate, doubtless, is are specialists in another phase of the futures market. a trade that is made as a scalping operation is not closed and is kept open as a speculation.

ECONOMICS OF THE SCALPING PROCESS.-The theory of scalper does is best explained by reference to the distinc on the speculative exchanges between "bid" prices and prices. For inactive objects of exchange trading and even rather active ones, prices that do not result in transactions published with this qualification, a bid price being wh more buyers express a willingness to pay and an asked p one or more sellers offer and are willing to take. The s between bid and asked prices may be small and moment may be large and long continued. For a commodity active in on an exchange the spread is bound to be small, and zero whenever a transaction takes place.

Scalpers' operations keep bid and asked prices closer toge they otherwise would be in other words, the spread bet and asked prices is more frequently reduced to zero.

Obviously a fluctuating market is better suited to the operations than one showing a steady movement during th SCALPING OPERATIONS.-As one Chicago scalper states t tion, practically all grain orders bought or sold in the pit first instance to the scalper. "At least four-fifths" have a at one end. If the scalper were taken out of the market, tions would be greatly increased, it is alleged, because ord commission houses would have to be put out at such pric down as would make them attractive. "Easily three-fourth grain futures handled, according to another trader, passes the hands of the scalper one way or the other. Data of q traded in, analyzed in Chapter IV, section 5, of this volume, these rough estimates.

of the business

cent and will The expected I that the pit and takes his to being edu e scalper con "pressure of g that prices s to sell when - the market t in the pit. ight to trade

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sell or buy and takes what is offered if the price suits him, according to his judgment of technical conditions and prospects. Trades with scalpers at both ends, however, often occur. The scalper's technique consists in judging whether a sag or a bulge is due to temporary pressure from one side or the other, according to the sources of offers and according to changes in quotations. He watches closely visible supply conditions. Sometimes he pays attention to more fundamental statistics of demand and supply, but he is more keen for temporary pit conditions.

Prompt judgment and action, accordingly, are essential to the success of the scalper. If there is anxiety to sell, so that offers are made at a figure he considers too low, he buys intuitively, and vice

versa.

It is said that the "true scalper" will have a trade at practically every different price (in eighths of a cent) touched in the range for the day, so that, for example, if the difference between the high and the low prices of the day is 4 cents, he will have trades at 32 different prices. This implies that the "true scalper" trades very readily and very heavily. It also explains the large proportion of "scratch trades.

3

SCALPERS AS A FACTOR IN THE SMALLNESS OF PRICE CHANGES.-The fact that price changes occur mainly in eighths, or by even smaller steps, may be attributed to the activity of the scalpers. Indeed, according to the accepted statement of the way they operate, the smallness of such changes must be principally their contribution to the market. It may be inferred not only that they keep the movement close to the usual unit in which prices are stated (the eighth) but that, through the use of the split price," they frequently bring the average movement between quotations considerably below the eighth.

Average price changes for the Chicago market in cents per bushel are presented for specified years in the following statement. These were obtained by dividing the sum of all the price changes (both up and down) during the day by the number of quotations for the day. The size of the statistical sample taken (the number of days covered) is also shown.

1912-13.. 1916-17.. 1920-21.

It is estimated by the Grain Futures Administration of the Department of Agriculture that for 1923 the "pit traders" or "scalpers," varying from 25 to 100 in number at different times, did fully 50 per cent of the wheat futures business on the Chicago board, and that "scratch" trades, most of which are for the account of "scalpers," constítuted approximately 30 per cent of the total. See Senate Document No. 110, Sixtyeighth Congress, first session, p. 3. For a definition of "scratch" trades, see footnote 7 on p. 74.

Subject to qualification for the period of high prices. An analysis of the continuous or 10-second quotations shows a marked increase of movements in larger fractions during the period of war prices.

See Vol. V, p. 68.