All About The Futures Market Contracts And Exchanges

All About The Futures Market Contracts And Exchanges

James J. Dehoiver

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.

The important point to remember when trying to trade futures for a profit is that it is the current price that is being traded and not the settlement price, which is at the future date. This means we want to be buyers of the contract if we think that the price will increase, and sellers of the contract if it looks like it is going down.

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.

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 use of futures in the farming industry has many benefits such as allowing the farmer to be able to plan ahead as he already knows what kind of profit he can expect from his crop of say coffee beans. The price may not be the best and the merchant may make a killing but the risk is reduced.

It makes sense for the farmer and the merchant to get together early in the season and agree the price to be paid for the produce at harvest time. This way the farmer can plan his expenses and the merchant can set his prices. In effect they are negotiating a type of futures contract, which provides them a way of eliminating the risk they face due to the uncertain future price of coffee beans.

The type of futures contract that you are trading is usually determined by the underlying asset, which could be either commodity based or financial based, such as stocks or bonds. This is a big change from the origins in the farming market.

It is important that both the quality and quantity of the produce in the contracts is regulated carefully, this is why the CBOT was founded in 1848. They now regulate many items which are as diverse as silver, corn and bonds

In 1919, the Chicago Mercantile Exchange (CME) was created. The exchange has provided a futures market for many commodities including pork bellies & live cattle. In 1982, it introduced a futures contract on the S&P 500 stock index.

The London International Futures and Options Exchange (LIFFE) was founded in 1982. Futures markets traded on LIFFE include the FTSE100, the GILT and Short Sterling. LIFFE has experienced huge growth, over 40% a year, since it started. In 2001 a record 216 million contracts were traded, representing approximately 96 trillion in value.

In Germany the EUREX is a big exchange and is 100% electronic, it started out as the DTB in 1990 before electronic systems became popular, at the time open outcry pits systems were still in use by many exchanges.

One of the biggest futures markets in the world was the German Bund, which, during the first half of the 90's, was the biggest contract traded on LIFFE. The Bund pit on the floor of LIFFE was the biggest and the most active, it was the heart of the trading floor. The Bund was also traded on the DTB, but in much smaller quantities.

Trading Futures online is now very popular among traders because of the good leverage and liquidity available, however unless you learn how to trade correctly you can lose a lot of money fast. On the other hand, well trained futures traders can make consistent daily profits by following a disciplined and well throughout trading strategy.

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