A lumber Exchange for Physical (EFP) is a private agreement between two parties, where one party agrees to take a futures contract in exchange for delivery of the underlying physical commodity. An EFP is negotiated independent of the Exchange.

An EFP is a privately negotiated transaction conducted bilaterally between two parties where both parties have to follow a certain set of rules. EFPs call for the simultaneous execution of a futures contract and a corresponding physical transaction or a forward contract on a physical transaction.

One party would be the buyer of the futures and the seller of the physical commodity (lumber). The other party would be the seller of the futures and the buyer of the lumber.

From the point of view of the exchange, both parties just need to be able to move the related position. For lumber, this means the seller of the physical commodity needs to be able to move the lumber that’s being exchanged for the futures contracts.

The efficiency posed by EFPs is one major reason why two parties would enter into the agreement. The buyer gets to acquire the lumber for the agreed upon price without concerns of slippage and the seller gets to maintain the open futures positions of the contracts they receive from the buyer.

Insulating against price changes are a key motivating factor for EFPs. An EFP is a beneficial and efficient alternative for sellers who want to negotiate directly with buyers, and thus avoid the requirements of going through Exchange delivery.

Under Exchange rules, deliveries need to be made to facilities within the Chicago Switching District, and then the seller has 10 business days to load and ship the lumber in accordance with rules defined in CME Group Rulebook Chapter 63. The delivery is considered complete once the buyer provides the Exchange with proof of receipt into the facility within the Chicago Switching District.

There are penalties for not following Exchange delivery rules, so the flexibility of EFPs for lumber is another potential benefit for both parties. One upside to consider in an EFP for lumber is that a sale can take place outside the Chicago Switching District. Additionally, sales of lumber species that aren’t covered by CME Group contracts can take place in the EFP process.

Let’s look at an example of a lumber wholesaler that has excess supply and a building supply company that has several months of work booked in advance. The building supply company wants to hedge against the increasing price of lumber, so they take a position that is long futures. After realizing that they have mutually beneficial stances by transferring the underlying physical commodity for the long futures positions, the lumber wholesaler and building supply company agree to an EFP.

In this example, the wholesaler would negotiate with the building supply company to transfer the physical product and receive futures contracts in return. The building supply company will receive delivery of the physical lumber.

There are restrictions in place for which parties can execute lumber futures contracts – primarily for quality assurance reasons. The underlying physical commodity must originate from a mill in Exchange delivery, but anyone can deliver the physical product to buyers for Lumber futures contracts. Secondary locations, such as warehouses and wholesalers, can negotiate directly with buyers to EFP, broadening the pool of participants in the EFP process.

There are nuances in delivery for Lumber futures contracts that both seller and buyer will need to follow. A delivery of CME Group Lumber futures contracts consists of 27,500 board feet, with an allowable variance of 26K to 29K board feet. Typically, mills must deliver all loads of lumber by railcar to the Chicago rail switching district for normal contract execution. But delivery by truck is possible with EFPs because the negotiations take place directly between the two parties.

EFPs during the non-spot month are not beholden to Exchange delivery rules. Any species can be delivered to any delivery location, one of the more flexible benefits of the EFP process in lumber. EFPs during spot months can occur anywhere geographically, but need to conform to Exchange specifications of tally and species.

The last day to EFP is two business days prior to the 26th calendar day of the contract month.

Check CMEGroup.com for calendars to note any holidays observed and delivery date details.