A futures market serves as an auction platform where participants buy and sell commodity and futures contracts slated for delivery on a future date. Futures are exchange-traded derivatives contracts that establish the price today for future delivery of a commodity or security.
Examples of futures markets include prominent exchanges like the New York Mercantile Exchange (NYMEX), the Chicago Mercantile Exchange (CME), the Chicago Board of Trade (CBoT), the Cboe Options Exchange, and the Minneapolis Grain Exchange.
In the past, these trades were conducted via open outcry and hand signals in trading pits located in major financial hubs such as New York, Chicago, and London. As the 21st century progressed, however, the majority of futures trading transitioned to electronic platforms.
Key Takeaways
- A futures market is an exchange where futures contracts are traded by participants who aim to buy or sell these derivatives.
- In the U.S., futures markets are heavily regulated by the Commodity Futures Trading Commission (CFTC), and futures contracts are standardized by exchanges.
- The majority of trading in futures markets now occurs electronically, with notable exchanges including the CME and ICE.
- Unlike stock markets, futures markets often operate 24 hours a day.
The Basics of a Futures Market
To fully grasp what a futures market entails, it’s essential to understand the basics of futures contracts, which are the assets traded in these markets.
Futures contracts are agreements made as a means for producers and suppliers of commodities to mitigate market volatility. These contracts involve a negotiation with an investor who agrees to take on both the risks and rewards of a volatile market.
Futures markets or futures exchanges are platforms where these financial products are bought and sold for delivery at a pre-agreed date in the future, with the price fixed during the transaction. These contracts extend beyond agricultural products to include financial products and future values of interest rates.
Unlike other securities that are issued, futures contracts can be created as long as open interest increases. Futures markets, which typically grow when the stock market outlook is uncertain, play a vital role in the broader financial system.
Major Futures Markets
Large futures markets operate their own clearinghouses to generate revenue from trading and trade processing. Significant futures markets with in-house clearinghouses include the Chicago Mercantile Exchange (CME), the Intercontinental Exchange (ICE), and Eurex. Some markets, like the Cboe, rely on external clearinghouses, such as the Options Clearing Corporation, to settle trades.
The regulation of most futures markets falls under the Commodity Futures Trading Commission (CFTC) in the U.S., with exchanges frequently regulated by the national regulatory bodies of their respective countries. Futures market exchanges draw revenue from trading activities, trade processing, and imposing membership or access fees on traders and firms.
Futures Market Example
Consider a scenario involving a coffee farm and a roaster:
If a coffee farm sells green coffee beans at $4 per pound to a roaster, and the roaster sells the roasted coffee at $10 per pound, both parties profit at these rates. To maintain these profits, they agree on futures contracts to lock in these costs.
For the coffee farm: If the market price of coffee falls below the agreed rate, the investor pays the difference, protecting the farmer’s profits.
For the roaster: If the market price of green coffee rises above the agreed rate, the investor covers the difference, ensuring that the roaster still pays a predictable rate. Conversely, if the market price drops, the roaster pays the agreed price while the investor benefits from the profit.
In this way, futures contracts offer stability and predictability for both producers and buyers amid fluctuating market conditions.
Related Terms: commodities, futures contracts, trading pits, open outcry, financial derivatives
References
- CME Group. “Clearing”.
- ICE. “Clearing”.
- Eurex. “Eurex Clearing”.
- Cboe. “Cboe Futures Exchange”.
