What Are Futures

You’ve heard them mentioned on the business channels and read about them in the Wall Street Journal. You’ve even had your brother in law recommend them to you, but what exactly is a future or futures contract?

Let’s start at the beginning. Futures began as a hedging instrument used by individuals and companies in specific industries to insure against unforeseen price changes. For planning purposes, these companies needed to predetermine two things: the cost of their raw materials and at what price their products would sell. For example, a farmer can make a reasonable profit from his crop if he can be assured to net $14 per bushel. He therefore enters into a futures contract with an investor who thinks that corn prices will rise. For this guarantee the farmer would pay a premium to the investor who would take the risk. In short, the farmer gives up a small part of his profit to guarantee the rest. The investor takes the chance that corn prices will move in a manner advantageous to him.

Savvy investors immediately saw in this market the potential for rich rewards. They recognized that they could control large amounts of a product and therefore profit handsomely if their market foresight proved right. Futures trading, if done correctly, is a remarkably lucrative endeavor. Many fortunes have been won in this very way.… [Read More...]