Futures Purchase

Futures Purchase

Futures, the purchase and sale of commodities for future delivery. Futures provide a convenient mechanism for 'hedging' market risks; futures markets form an important part of many organized commodity exchanges or markets. They also facilitate arbitrage, widen the market and promote smooth adjustments of demand and supply.

The essence of futures trading is a contract by which one party agrees to deliver a quantity of the commodity concerned at a future time and a given price ('sells'), and the other agrees to accept (buys'). Generally, futures contracts differ from cash or forward contracts because their terms other than price are laid down by the market or 'exchange' in which they are made: e.g. the grade of the product is usually specified, and other grades may be delivered instead of it only if the price allows for differences. Delivery times are also usually subject to rules.

A person who buys a commodity for cash today in the stock market and then holds it over a time is 'speculating'. If price has risen in the spot market by the time he resells it (or sells the goods manufactured from it), he gains: if it has fallen, he loses. Such wind-all gains or losses are disturbing to manufacturers and traders who old stocks in the normal course of business. Hedging by means of futures contracts is an attempt to reduce such risks. Thus if, at the same time as he made a spot purchase, a trader sold a futures contract for a similar quantity, and if he cancelled ('bought in') his futures contract when he resold, loss or gain on the cash transaction due to price changes will tend to be cancelled by an opposite gain or loss on the futures transaction. Although a perfect hedge may be unattainable in practice (because cash and future prices may be 'out of line'), hedging permits some separation of the speculative gains or losses arising from commodity price changes and the profits from the normal business of trading or manufacturing. The risks are in fact shifted on to the speculators (brokers) who are specialists in such contracts. Hedging thus illustrates the way in which risk can be reduced by specialization of the market when normal forms of insurance are not possible.

An example of a futures market in commodities is the Liverpool Cotton Exchange.

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