Hedge Fund Managers and the Series 3 Exam
Those managers who engage in commodities and futures trading (and who don’t qualify for an exemptions) will need to register as commodity pool operators with the CFTC and become members of the NFA. In order to do this all owners and “associated persons” of the manager/CPO will need to take and pass the Series 3 exam. This article provides a brief overview of the Series 3 exam for hedge fund managers.
Commodities and Futures Contracts License
The NFA requires an individual to successfully complete the Series 3 in order to become qualified to sell commodities or futures contracts. The exam is designed for anyone who is going to act as an Associated Person, Commodity Trading Advisor, Commodity Pool Operator, Introducing Broker, or Futures Commission Merchant. [Note: under the forex registration rules, those managers who trade in the spot forex markets will soon also need to take the Series 3 and a new exam called the Series 34 exam.] The Series 3 is also a prerequisite to the Series 30 Futures Branch Manager exam.
The Series 3 exam is required of individuals who conduct business with the public on the U.S. futures exchanges and:
- offer or solicit business in futures or options on futures at a futures commission merchant (FCM) or introducing broker (IB) or who supervise any such person.
- are associated with a commodity trading advisor (CTA) who solicits discretionary accounts or who supervises persons so engaged.
- are associated with a commodity pool operator (CPO) who solicits funds for participation in a commodity pool or who supervises such persons.
The NFA Series 3 Exam is administered by FINRA. There is a two-step process that a candidate must complete to be able to take the Series 3 Exam.
Step 1 – The individual must apply with FINRA to take the exam by completing and submitting an application form and payment, or by submitting the application online. The testing application form can be downloaded from the FINRA’s web site. Effective January 2, 2009, the fee for an individual to take the Series 3 National Commodity Futures Examination will be $105.
Step 2 – Once the U10 registration has been approved and processed by FINRA, a Notice of Enrollment will be emailed to the candidate. FINRA will assign a 120-day window during which the exam can be scheduled and taken. The candidate may then contact their local test center to schedule an appointment to sit for the exam. Due to the many sessions administered at testing centers, the candidate should schedule test-taking as far in advance as possible to secure an appointment on the desired date.
The exam is delivered via a computer system specifically designed for the administration and delivery of computer-based testing and training. Exams are given at conveniently located test centers worldwide and an appointment to take your exam can be scheduled online or by calling your local center. For a list of test centers in your area (U.S. and International) click here.
Series 3 Exam Overview
The Series 3 Exam for commodity futures brokers is divided into two parts – futures trading theory and market regulations. Each part must be passed with a score of at least 70 percent. There are 120 total multiple choice and true/false questions, and exam takers are provided 2 hours and 30 minutes to complete the exam. The Series 3 Exam also contains 5 additional experimental questions that do not count towards the exam taker’s score, and additional time is built into the exam to accommodate for these questions.
The Series 3 exam is divided into ten topics and is graded in two main parts: Market Knowledge and Rules/Regulations. The Market Knowledge part covers the first nine of the following topics, and consists of 85 questions. The Rules/Regulations part covers category ten, and consists of 35 questions. You must achieve a 70% on each part in order to pass the exam.
Part 1: Market Knowledge – The first part of the Series 3 exam covers the basics of the futures markets. Exam takers will need to understand futures contracts, hedging, speculating, futures terminology, futures options, margin requirements, types of orders, basic fundamental analysis, basic technical analysis and spread trading.
Part 2: Rules/Regulations – The second part of the Series 3 exam consists of market regulations. Exam takers must familiarize themselves with relevant NASD rules and regulations for this part of the exam.
- Futures Trading Theory
- Margins, Limits, Settlements
- Orders, Accounts, Analysis
- Basic Hedging
- Financial Hedging
- General Speculation
- Financial Speculation
Useful Terms to Know for the Series 3 Exam
Exam takers are expected to be familiar with the following terms and definitions prior to taking the Series 3 exam. The definitions presented below have been extracted from Investopedia.
Bucketing: A situation where, in an attempt to make a short-term profit, a broker confirms an order to a client without actually executing it. A brokerage which engages in unscrupulous activities, such as bucketing, is often referred to as a bucket shop.
Delta: The ratio comparing the change in the price of the underlying asset to the corresponding change in the price of a derivative. Sometimes referred to as the “hedge ratio”.
Double Top: A term used in technical analysis to describe the rise of a stock, a drop, another rise to the same level as the original rise, and finally another drop.
First Notice Day: The first day that a notice of intent to deliver a commodity can be made by a clearinghouse to a buyer in fulfillment of a given month’s futures contract.
Intrinsic Value: 1. The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. Value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value. 2. For call options, this is the difference between the underlying stock’s price and the strike price. For put options, it is the difference between the strike price and the underlying stock’s price. In the case of both puts and calls, if the respective difference value is negative, the intrinsic value is given as zero.
Inverted Market: In the context of options and futures, this is when the current (or short-term) contract prices are higher than the long-term contracts.
Long Hedge: A transaction that commodities investors undertake to hedge against possible increases in the prices of the actuals underlying the futures contracts.
Offset: 1. To liquidate a futures position by entering an equivalent, but opposite, transaction which eliminates the delivery obligation.2. To reduce an investor’s net position in an investment to zero, so that no further gains or losses will be experienced from that position.
Scalpers: A person trading in the equities or options and futures market who holds a position for a very short period of time, attempting to make money off of the bid-ask spread.
Straddle: An options strategy with which the investor holds a position in both a call and put with the same strike price and expiration date.
Please contact us if you have any questions or would like information on how to start a hedge fund. Other related hedge fund law articles include: