History of futures

While the trading of futures contracts is a seemingly modern one, where there is a great deal of speculative investing, in reality the commodity future contract is one of the oldest financial instruments, and arose from far more mundane concerns.

The first known organised futures exchange originated in 1710 at the Dōjima Rice Exchange in feudal Osaka, Japan. During the 17th century the Japanese economy flourished like never before, and the merchant class prospered. Around this time the rice brokers and moneychangers gathered in the Dōjima area, the Rice Exchange being first established in 1697 when it received a trading license from the Shogunate.

Members of the samurai class, including feudal lords, were paid in rice rather than money, and so the rice brokers and moneychangers played a vital role in the economic system. Samurai needed a method of storing and trading their payments (in rice) and converting them into money. It was in 1710 that the traders and brokers of Dōjima developed the concept of trading in futures, as samurai sought to obtain a stable exchange rate between the rice they would paid in the future, as opposed to being subject to a highly variable rate of exchange that could leave them incredibly wealthy one moment, and impoverished the next.

The concept of commodities futures is an old one, then, and there are many other such exchanges throughout history, such as the London Metal Exchange, founded in 1877. One of the largest, the Chicago Mercantile Exchange, was a means for farmers to stabilise and predict the prices they would receive for their harvests.

Before the futures market existed, farmers would grow crops, harvest them and then take them to market. They would hope to get as good a price as they could manage, but with no idea of demand in advance, the supply of crops would often outstrip what was required and unpurchased crops would go to waste. On the other hand, if a crop was out of season or harvests had been poor, prices soared and derived goods would be extremely expensive.

Central markets were established to eliminate these problems, allowing farmers to either sell their goods for immediate delivery, or for forward delivery. These forward contracts were the precursor to modern futures contracts, and were similar in many ways. They allowed both buyer and seller to account for future revenues and costs more accurately. The farmer knew how much he would receive, and the dealer knew what he would have to pay.

Soon, these contracts were changing hands before the delivery date even arrived. If the dealer no longer wanted the produce, he could sell the contract to someone who did; if the farmer didn’t think he could deliver, or didn’t want to, he could sell it to another farmer. The prices that these contracts changed hands for was dependent on what was going on in the wider market. If bad weather came, those who had contracted to sell would have more valuable contracts as the supply would be low; if weather was good, then the value of the contract would be much lower in the face of an abundant harvest. Before long however, a trading market developed for the contracts themselves between parties that had no interest in ever buying or selling any actual crops, as wily investors realised that fluctuations in demand, supply and prices would affect the relative worth of the contracts, which remained fixed. They were speculators, seeking to make profits on the fluctuations of the market, much like modern futures traders.

This information has been prepared by IG Markets Limited. ABN 84 099 019 851, AFSL 220440. We provide an execution-only service. The material on this page does not contain (and should not be construed as containing) personal financial or investment advice or other recommendations, or an offer of, or solicitation for, a transaction in any financial instrument, or a record of our trading prices. No representation or warranty is given as to the accuracy or completeness of the information. Consequently any person acting on it does so entirely at his or her own risk. The information provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who view it. IG accepts no responsibility for any use that may be made of the comments and for any consequences that result. Website: www.ig.com/au