What is Futures

Futures markets allow companies and individuals to protect themselves against fluctuations in the price of an asset that they are interested in. This allows them to sell an asset in advance giving them the ability to make plans for the future in the knowledge that they have a fixed price.

Futures have been with us for a long time. The first use of futures can be traced back to 1650's during the Tokugawa era in Japan. Feudal lords used to collect rents from their tenants in the form of rice.

Not only would they trade the rice that they had collected but also, they would often trade their future rice delivery. This was the start of what became the Dojima Rice Market. Even today rice futures can be traded but the range of the market has expanded to include many other things.

For new traders the word future can be confusing as the word implies that everything takes place in the future. What actually happens is that the settlement takes place in the future but the price is agreed upon on that day (today).

It also important to realize when trading futures that just because you bought it does not mean that you have to keep it until settlement. You can sell the contract long before delivery of the contract is due.

Like many other markets you also do not need to necessarily own the asset before you sell it. You can sell a futures contract just as easily as you can buy it.

Because futures have been around for such a long time nearly all markets around the world that trade in futures are highly regulated. The fundamental principle of a future is fairly simple.

You buy or sell something at today's price for delivery in a future date. This can prove to be extremely valuable to farmers and organizations to protect themselves against future fluctuations in price.

Let's use a farmer for example. This allows him to sell his crop before it is harvested. In times when the harvest is plentiful and many other farmers with the same crop have had bumper harvest then there will be an over abundance of that crop. This will generally lead to a lower price.

In times when the harvest is bad and other farmers are also experiencing bad harvests the price will be high, as there is a limited supply of the asset.

There will however be times when it is very difficult to know when a crop will be good or bad and for the farmer this can be devastating in planning his future.

One way he can over come this is by selling his crop on the futures market at a price agreed upon today but only for deliver in the future.

If he agrees on a price today and there is a very short supply of that crop on the agreed delivery date then the farmer may very well have been better waiting to deliver his crop at the market price. What the future does it take the uncertainty of the process away.

Futures contracts are generally divided into two distinct groups:

1) Financial assets such as a group of stocks, a market index or bonds.

2) Commodity asset such as coffee beans, wheat and pork bellies.

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