Futures Markets: What, Why and Who?

The frantic shouting and signaling of bids and offers on the trading floor of an open-outcry futures exchange undeniably convey an im-pression of chaos. The reality, however, is that chaos is what futures markets replaced. Prior to the establishment of central grain markets in the mid-nineteenth century, the nation’s farmers carted their newly harvested crops over plank or dirt roads to major population and transportation centers each fall in search of buyers. This seasonal supply glut drove prices downward to giveaway levels and even to throwaway levels as corn, wheat and other crops often rotted in the streets or were dumped in rivers and lakes for lack of storage. Come spring, shortages frequently developed and foods made from corn and wheat became barely affordable luxuries.

Throughout the year, it was each buyer and seller for himself, with neither a place nor a mechanism for organized, competitive bidding. The first central markets were formed to meet that need. Eventually, contracts were entered into for forward as well as for spot (immediate) delivery. So-called forwards were the forerunners of present day futures contracts.

Spurred by the need to manage the price and interest rate risks that exist in every type of modern business, today’s futures markets have also become major financial centers, without the existence of which even the U.S. Treasury or Federal Reserve System would be hard-pressed to carry out their fiscal responsibilities. Current market participants are just as likely to be mortgage lenders, investment bankers and multinational corporations as farmers, grain merchants and exporters. Wherever there are hedgers who need to transfer price risks, there are speculators willing to selectively accept the risks in the pursuit of profit.

Futures prices, whether arrived at either through open outcry or by electronic matching of bids and offers, are immediately and continuously relayed around the world. A farmer in Nebraska, a merchant in Amsterdam, an importer in Tokyo and a speculator in Ohio have simultaneous and equal access to the latest market derived price quotations. Should they choose, they can establish a price level for future delivery—or for speculative purposes— simply by instructing their broker to buy or sell the appropriate contracts.

Images created by the fast-paced activity of a trading floor notwithstanding, regulated futures markets are more than ever a keystone of the world’s most orderly, envied and intensely competitive marketing system.

Reprinted with permission from the National Futures Association. Copyright 2002.