Any overview of managed futures must begin with a description of futures contracts.  A futures contract is a legally binding agreement designed to allow buyers and sellers to lock in a price on a specified good (e.g., physical commodity, fixed-income security, equity index, or currency) on a specific settlement date.  They are standardized according to quality, quantity, delivery time and location for each contract.  The only variable is price.

 

Standardized foreword contracts evolved into today's futures contracts. For example, a June CME Live Cattle futures contract would require the seller to deliver 40,000 pounds of live cattle of a certain quality to the buyer upon expiration of the contract.

 

A great advantage of standardized contracts was that they were easy to trade. As a result, the contracts usually changed hands many times before their specified delivery dates. Many people who never intended to make or take delivery of a commodity began to actively engage in buying and selling futures contracts. Why? Because they were speculating or taking a chance that as market conditions changed they would be able to buy or sell the contracts at a profit. The ability to eliminate a position on a contract by buying or selling it before the delivery date is called offsetting.  Offsetting is a key feature of futures trading. According to the CME Group (http://altavra.co/wpabx), only about 3% of all futures contracts currently result in physical delivery. Most people clear or eliminate positions before the contract expires.

 

Every futures contract has a last day of trading. All open positions must be closed out by this last trading day. For a physical delivery contract like CME Live Cattle, the open positions can be closed out by making an offsetting futures trade or by making/taking physical delivery of the cattle. For cash-settled futures contracts, positions can be closed out by making an offsetting futures trade or by leaving the position alone and having it closed out by one final mark-to-market settlement adjustment.

How Did Futures Trading Begin?

Today's futures markets, and the principles that underlie futures trading, evolved from practices that are centuries old, dating back to the ancient Greek and Roman markets.  Futures markets in the United States existed as early as 1752.

 

The history of modern futures trading began in the Midwest in the early 1800s.  It was tied closely to the development of commerce in Chicago and the grain trade in the Midwest.  As grain trade expanded, a centralized marketplace, the Chicago Board of Trade (CBOT) was formed in 1848 by 82 merchants.  Soon after that, trading began in grains, cattle, eggs and other commodities.

 

In the mid-1840's, Chicago began to emerge as the market center for farmers in neighboring states. At harvest time, farmers converged on the city to sell their grain. There was often so much grain that the farmers had to dump much of it into Lake Michigan because there were not enough buyers and there was no way to store it. Often by spring, grain was in short supply again. The excess supply in the fall forced the farmers to lower their prices to induce the grain merchants to buy their grain. But in spring, when supplies were all but depleted, demand for grain was so great that prices began to rise astronomically.

 

A few of the more savvy grain merchants decided to band together in 1948 to form an organized gain exchange, the Chicago Board of Trade. The Chicago Board of Trade provided a central meeting place where buyers and sellers of grain could get together and conduct business. with a formal exchange operating, wealthy investors saw an opportunity to build huge silos to store the grain for year-round consumption. This helped smooth out the grain supply issues and helped bring some price stability to grain throughout the course of each year.

 

The success of the Chicago Board of Trade inspired others to create exchanges that would assist the process of buying and selling futures contracts on other farm products. In 1874, the Chicago Produce Exchange was formed, later named the Chicago Butter and Egg Board, and then in 1919, the CME (Chicago Mercantile Exchange). The commodities traded at the exchange throughout the early years were butter and eggs. Later, the Chicago Mercantile Exchange began offering trading in hides, onions and potatoes.

 

During the 1950's , the Chicago Mercantile Exchange also began trading contracts on turkeys and frozen eggs. In 1961, the Chicago Mercantile Exchange introduced a new contract, frozen pork belies, which put the exchange on the map.

 

When Did Trading In Financial Futures Start?

In 1972, financial futures were introduced with the launch of eight currency futures contracts. Today, the Chicago Mercantile Exchange, now CME Group, is the largest futures exchange in the United States.  Contracts traded in futures now range from the S&P 500 Stock Index, to Crude Oil to Pork Bellies.

 

THE RISK OF LOSS IN TRADING FUTURES, OPTIONS AND OFF-EXCHANGE FOREX CAN BE SUBSTANTIAL.  PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. 

 

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