Futures Markets: Addressing Economic Need

A farmer planting a 10,000-bushel soybean crop in Chana, Illinois, might want to sell part of it now to ensure a certain price upon harvest. Similarly, a food-processing company might want to purchase soybeans now to protect against future price increases. An orange juice manufacturer might want to lock in a supply of oranges at a definite price now to avoid the risk of a winter freeze pushing up prices. These economic needs create futures markets.

The concept of a forward market is based on participants facilitating the purchase and sale of products that will not be produced or available until a specific time in the future.

Any futures market is based on some underlying product, often a physical commodity, offering producers or end-users the ability to hedge against adverse price movements in the value of the end product.

Long Position

Agree to buy the asset in the future.

Short Position

Agree to sell the asset in the future.

Settlement

Can be physical delivery or cash settlement.

Sellers of these products may wish to lock in as high a price as possible to ensure they make at least a profit or, at worst, cover production costs. End-users may wish to hedge against rising prices to ensure a reasonable price for any commodity and control their costs.

The more producers, buyers, sellers, and hedgers that interact in any futures market, the more speculators are drawn in, creating additional liquidity and generally improving market conditions.

Speculative participants take directional positions across 3- to 18-month horizons, exploiting embedded leverage where initial margin represents only a fraction of notional exposure. Depending on the commodity, market volatility, and exchange requirements, an investor typically posts a single-digit to mid-teens percentage of the contract’s notional value — the full dollar value of the position the contract controls, defined precisely under Contract Details below — and the micro-sized contracts now listed on most products scale that requirement down proportionally. Commissions per contract are trivial relative to notional — which is precisely the problem, since the cost of the position bears no relation to the risk you have taken on.

Whether you’re a speculator willing to assume risk for profit or an investor adopting a hedging strategy to protect a position, futures allow you to lock into prevailing prices.