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What are Futures? A futures contract is a legally binding agreement between a buyer and a seller that calls for the seller to deliver to the buyer a specified quantity (and quality, for commodities) of a specific asset at a future date for a price agreed today. It is important not to get confused about what the word future refers to. Futures traders are not trading future prices, we are trading today's prices, but the settlement is taking place in the future. So we buy if we think prices will increase and sell if we think prices will drop. If I buy (or sell) a futures contract today, I don't have to hold it until the contract expires; I can simply choose to sell it (or buy it) in the market at the prevailing price. Futures contracts are bought and sold in the regulated environment of a futures exchange, such as the Chicago Board of Trade (CBOT) in the U.S. and the London International Futures and Options Exchange (LIFFE) in the U.K. Origins of Futures Futures were originally developed to help offset the risks and uncertainties experienced by farmers and merchants due to the fluctuating supply and demand for produce. Take for example a coffee plantation farmer. The price that he will receive for his beans will vary according to the vagaries of supply and demand. In a year when supplies are limited and demand is high, prices will be high. In a year when demand falls and the supply is plentiful, the price will fall. The coffee merchant also experiences the same turbulence in prices due to fluctuating supply and demand. The only difference is that a good price for the farmer is bad for the merchant and vice versa. If neither the farmer nor the merchant knows what the price of beans will be at harvest time, it is difficult for them as they do not know how much money they can spend now in anticipation of future profits. |
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