Futures markets perform 2 vital economic functions: Price Discovery & Transfer of Risk. The price paid for goods and services depends to a great extent on how well businesses handle risk. With futures, businesses can minimize their price risk, which, in turn lowers their cost. The price savings is a benefit to consumers, whether it’s lower food prices, cheaper gasoline, or a better return on a pension or investment fund.
The need for efficient forward pricing and risk management is the reason for the tremendous growth in futures markets. Exchanges like the Chicago Board of Trade (CBOT) and Chicago Mercantile Exchange (CME) enable raw material buyers and sellers, financial intermediaries, and global trading firms to manage the prices they pay. Futures can also limit interest rate and foreign exchange risk. Lastly, traders worldwide speculate on the futures markets in an attempt to generate trading profits.
The history of futures trading began on the Midwestern frontier in the early 1880s. It is closely tied to commerce in Chicago and the Midwest grain trade. Chicago’s strategic location in the middle of the fertile farmlands and alongside the Great Lakes, allowed the city to play a key role in the cash grain trade. However, problems of transportation, storage, and communication led to a chaotic marketing situation. In order to bring about a more orderly system, 82 merchants in Chicago grouped together to form a centralized market place which eventually lead to the birth of the futures markets.
In 1848, the Chicago Board of Trade (CBOT), the world’s first futures exchange, was started. It provided a place where buyers and sellers could meet to trade commodities. In the early days, traders used “cash forward” contracts. In 1865, as the market matured, “futures contracts” were introduced. These contracts are standardized, so that buyers and sellers can exchange one contract for another and offset their obligation to deliver the underlying commodity. Grain merchants, processors, and agriculture companies found that with futures contracts, they could protect themselves from erratic price movements in these commodities.
Speculators, on the other hand, are attracted to the futures markets because of the large profit potential. In speculation (which means to assume risk), the objective is to profit from price movement. Speculator participation also provides an important economic function because it provides liquidity to the marketplace.
In the early days, speculators were limited to agricultural commodities. However, in recent years, the futures markets have expanded worldwide and now include a wide range of agricultural, industrial, and financial instruments. In 2003 single-stock futures became the latest futures contracts available for speculation.
Disclaimer The risk of trading can be substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance is not necessarily indicative of future results.
Futures Trading Disclaimer: Transactions in securities futures, commodity and index futures and options on futures carry a high degree of risk. The amount of initial margin is small relative to the value of the futures contract, meaning that transactions are heavily “leveraged”. A relatively small market movement will have a proportionately larger impact on the funds you have deposited or will have to deposit: this may work against you as well as for you. You may sustain a total loss of initial margin funds and any additional funds deposited with the clearing firm to maintain your position. If the market moves against your position or margin levels are increased, you may be called upon to pay substantial additional funds on short notice to maintain your position. If you fail to comply with a request for additional funds within the time prescribed, your position may be liquidated at a loss and you will be liable for any resulting deficit.