Futures for the Layman

Futures, in the financial sense of the word, are closely related to Options but with one crucial difference: while Options contracts give their purchaser the right to buy or sell a certain commodity or security by or at a certain date, a Futures contract imbues the trader with the obligation to settle the contract. In this respect, futures contracts entail a certain level of urgency that increases as the settlement (or delivery) date approaches. Futures trading can become very complicated as traders seek to cover their positions by purchasing additional futures contracts that protect their positions or by selling the contracts before the settlement date, hopefully at a profit. While the price of a futures contract can vary widely around the time of purchase, as time passes the price will converge towards the actual price of the commodity or security, matching it on the settlement date.

Futures, to most people, are associated with commodities like oil, gold, base metals, and agricultural products like corn, coffee and the inimitable pork bellies. The field of futures trading is fraught with speculative overtones as a host of factors can influence the price of a futures contract from day to day, or even from hour to hour! So called Acts of God, such as sudden storms or mining discoveries can and do directly impact futures prices. An examples of this would be a cold weather snap in Florida that damages the orange crop, affecting the price of orange juice futures, or the outbreak of war in the Middle East that will drive up the price of oil and gold futures.

Futures are exchange traded derivatives that are chiefly traded at dedicated exchanges like the Chicago Mercantile Exchange (CME) and the Minneapolis Grain Exchange (MGE), though they can also be traded on the NASDAQ and most other major stock exchanges. Futures are also traded internationally - even small countries like Argentina (Rosario Futures Exchange) and Bulgaria (Sofia Commodity Exchange) offer thriving futures trading markets. Larger countries like Japan have a wide variety of specialized futures exchanges such as the Maebashi Dried Cocoa Exchange, the Kobe Rubber Exchange (KRE) and the Tokyo International Financial Futures Exchange (TIFFE). Each exchange has a clearinghouse that performs the function of a counterparty on all futures contracts traded at the exchange and sets margin requirements so that the system cannot be abused. Most futures trading is done by institutional investors and funds that can designate specialists in futures trading to conduct transactions in the name of the institution - and avoid the prospect of a truckload of pork bellies suddenly appearing outside their front door!

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