Future Business

Futures (business), agreement to deliver a commodity at a future date at a specific price. A commodity refers to any item that can be bought or sold and delivered. Commodities include agricultural products, metals, oil and natural gas, bonds, currencies, and other goods.

Futures, also called futures contracts, are standardized according to the amount of the commodity, the quality, and the exact date of delivery. For example, a futures contract for corn specifies the delivery of exactly 5,000 bushels of a certain quality of corn on a specific date.

Futures originated in the 19th century when farmers and wholesale buyers began using forward contracts. Forward contracts assured future delivery of agricultural produce at set prices. Terms of the forward contracts varied.

For example, one farmer might make a contract with a buyer for the delivery of 975 bushels of corn in three weeks, while another farmer might contract for 1,500 bushels in five weeks. By 1865 the contracts had become standardized according to amount, quality, and date of delivery and began to be called futures contracts.

Business people and farmers buy and sell futures contracts to reduce the risk of price changes in the commodities they deal in. Every year farmers run the risk of losing money if prices have fallen for their crops by the time their crops are ready for market. Farmers can offset this risk by buying a futures contract that will still earn a profit if crop prices fall.

For example, if a wheat farmer owns a 90-day futures contract to sell wheat at $5.00 a bushel, and prices fall to $4.25 a bushel in 90 days, the farmer can sell the contract for a profit. The farmer will earn less for the crop, but will profit from the futures contract. This method of risk reduction is called hedging.

Futures are not just useful contracts for farmers, wholesalers, and merchants. They have become financial instruments, like stocks and bonds, and investors trade them in large quantities on exchanges such as the Chicago Board of Trade(CBOT) and the Chicago Mercantile Exchange (CME).

Today, investors are not required to actually deliver or receive the commodities listed in the contracts. Less than 10 percent of present-day futures contracts result in an actual exchange of goods. The majority of contracts are settled in cash.

While useful for hedging, the futures market is a risky area for speculative investing. Because worldwide supply and demand for commodities changes, commodity prices often fluctuate rapidly. Investors who are willing to assume a good deal of risk—that is, speculators—are the ones who trade in futures.

Speculators try to determine whether the price of a certain commodity is going to rise or fall. If they are correct, they can often make large profits as their futures contracts rise in value. However, poor judgment or bad luck can result in equally large losses.