What are futures and why are they traded?

The essence of what defines a futures market lies in its name. The trade in question involves a commodity or financial instrument for a future delivery date–as opposed to the present time. If a farmer wished to make a current sale, he would sell his crop in the local cash market.

However, if the same farmer wanted to lock in a price for an anticipated future sale (for instance, the marketing of a still unharvested crop), he would have two options:

  1. He could locate an interested buyer and negotiate a contract specifying the price and other details (quantity, quality, delivery time, location, etc.).
  2. He could sell futures.

Futures contracts are made in an attempt by producers and suppliers of commodities to avoid market volatility. These producers and suppliers negotiate contracts with an investor who agrees to take on both the risk and reward of a volatile market.

Until the early 1970s, futures markets were restricted to commodities like: wheat, sugar, copper and even cattle. Since that time, the futures arena has expanded to incorporate additional market sectors, the most significant of which are: stock indexes, interest rates and forex. The same basic principles apply to these financial futures markets. Trading quotes represent prices for a future expiration date rather than current market prices.

Financial markets have experienced spectacular growth since their introduction. Today, trading volume in these contracts dwarfs that in commodities. Nevertheless, futures markets are still commonly, even erroneously, referred to as commodity markets–and these terms are almost synonymous.

In the earliest days, such trading was carried out through open outcry and the use of hand signals in trading pits–located in financial hubs such as New York, Chicago, and London. Like most other markets, futures exchanges have become mostly electronic.

In 2021, the CME Group boasted the largest futures exchange in the world. Headquartered in Chicago, it has offices in major cities across the globe.

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