A Futures Market: What Is It?
A futures market is an auction market where participants trade futures and commodities contracts for delivery on predetermined dates in the future. Futures are exchange-traded derivatives contracts that guarantee the delivery of a good or asset at a price established today, regardless of when it is delivered.
The New York Mercantile Exchange (NYMEX), Chicago Mercantile Exchange (CME), Chicago Board of Trade (CBoT), Cboe Options Exchange (Cboe), and Minneapolis Grain Exchange are a few examples of futures markets.
Trading pits in financial centers like New York, Chicago, and London were where such trading was formerly conducted through open outcry and the use of hand signals. Like most other markets in the twenty-first century, futures exchanges have mostly moved toward electronic trading.
The Fundamentals of the Futures Market
It’s critical to comprehend the fundamentals of futures contracts, the assets exchanged in these markets, in order to completely comprehend what a futures market is.
Producers and suppliers of commodities use futures contracts to try to reduce market volatility. With an investor who is willing to accept both the risk and reward of a volatile market, these producers and suppliers negotiate contracts.
These financial instruments are purchased and sold on futures markets or futures exchanges for delivery at a certain future date with a price set at the time of the transaction. Futures markets are used for more than only agricultural contracts; they are also used to buy, sell, and hedge financial products including interest rate futures.
Contrary to other securities that are issued, futures contracts can be manufactured or “generated” as long as open interest rises. Futures markets, a vital component of the financial system, are larger than commodities markets (and typically grow when the outlook for the stock market is uncertain).
Principal Futures Markets
Large futures markets operate their own clearinghouses where they can profit from both the trades themselves as well as the processing of trades after the fact. The Chicago Mercantile Exchange, ICE, and Eurex are some of the largest futures markets that run their own clearinghouses.
Options Clearing Corporation, an external clearinghouse, settles trades on other marketplaces like Cboe.
The Commodity Futures Trading Commission (CFTC), the principal American agency in charge of futures market regulation, has records on almost all futures markets. The regulatory authority of the nation in which an exchange is based typically oversees exchanges.
Futures Market Illustration
For example, if a coffee farm sells green coffee beans to a roaster for $4 per pound and the roaster sells those beans after they have been roasted for $10 per pound, and both are profitable at that price, they will wish to keep those prices stable. The investor consents to pay the coffee grower the difference if the price of coffee falls below a predetermined level.
The investor keeps earnings if coffee prices rise above a certain level. If the price of green coffee exceeds the agreed-upon level for the roaster, the investor pays the difference, and the roaster receives the coffee at the predetermined price. The roaster pays the same amount and the investor receives the profit if the cost of green coffee is less than the agreed-upon price.