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Futures markets have their existence in relation to an
underlying cash market. The cash market is a physical commodity such as wheat, cattle,
gold, T-bills, etc. that is bought and sold between parties. Due to cash market price
volatility, the futures markets emerged in part as a way to help ensure price stability at
a later delivery date.
A futures contract is an agreement between two parties that a specified quantity of a
commodity at a specified price will be delivered at a specified future date. In actuality, |
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| few futures contracts are settled through
delivery as the majority of market participants liquidate their contracts before delivery
is scheduled to be made. |
There are two primary participants in the futures markets: the hedger
and the speculator. The hedger seeks to protect a cash position against adverse price
movements while the speculator provides market liquidity by providing risk capital in the
hopes of making a profit through prediction of price movements.
A hedger can be the owner of a commodity who will want to sell at the highest possible
price, or a buyer that will want to buy the commodity at the lowest possible price. For
example, let’s assume that the price of corn has increased over a dollar a bushel in
two months time due to high demand and supply shortages. A cereal maker could have
purchased a futures contract at the lower price two months ago in anticipation of his
future cash purchase.
One or more speculators in the above example could have sold their previously bought
futures positions to the cereal maker at his asking price, thus offsetting the speculative
position and exiting them from the market.
Speculators are in the markets to make a profit. They play a vital economic role by
providing the capital needed and assuming the financial risks involved in moving world
commodities around the globe. The interplay between speculators and hedgers is what makes
the markets work.
© Brett Krkosska - All Rights Reserved
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Related Reading
 Futures Trading & Discipline
Speculative trading in the futures markets can be a highly emotional and stressful
venture. That the majority of small investors in the futures markets are losers is no
surprise. Self-discipline is the key to winning this high stakes game.
Futures: The Basics of Trading in
Commodities
Commodity futures trading offers the potential for very lucrative returns relative to
money invested. With the potential for great reward comes the equal potential for great
loss. Understanding the power of leveraging is your first knowledgeable defense against
loss.
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