In the markets for agricultural commodities that lend themselves to objective grading, a system of trading in futures contracts (contracts calling for the delivery of specified kinds and amounts of the physical commodity at a specified time and place) has grown up along with the marketing system for the physical product.
Definition of Futures Market
A futures market may be defined as a market where transactions are carried on for both future delivery and payment by the seller and the purchaser respectively. It implies that the seller contracts to deliver the goods at some future date as fixed in the contract and the buyer also agrees to take delivery of the same goods by cash payment at the same future date. In other words, the future market is based upon the contracts to sell and to buy a given quantity of certain grades of a product during a specified future month at a price set out by the rules of the Commodity Exchange and the particular contract.
The essence of future trading is that a contract is entered into by means of which one party agrees to deliver a certain amount of the product at a future time and at a stipulated price, whereas the other party agrees to accept that amount at that future time and price. The term “future trading” covers both speculative transactions, in which futures are bought and sold for the purpose of making. profits from price changes, and hedging transactions, entered into to avoid the inconvenience and loss resulting from price changes.
How the Futures Trading Takes Place
Goods are bought and sold for delivery on a specified future date. Neither payment is made nor goods are delivered to the buyer until the time comes for the fulfillment of the contract. We may cite an example for the clarification of the problem. Suppose that a manufacture of jute goods thinks that the prices of raw jute may rise in future and so he may find it expedient to make contracts just now to buy his raw jute for future. When the time fixed for the delivery and payment comes he buys the goods at the contracted price even if the price has risen. Thus, the manufacturer is relieved of all worry as to the price changes in future.
If the parties enter into future contract with a definite intention of completing it by delivery, the transaction is genuine. But if the contracts are made between the buyer and the seller not to be completed by delivery but simply by cancelling the contracts at some future date by paying up the differences in price, such dealings are purely of speculative nature. In such cases, the transaction is settled by payment of differences. The party who sustains loss on the contract is to pay the difference.
Mr. A has sold jute, for instance, to Mr. B for three month’s delivery. If the price of the jute, at the end of the three month’s period, goes up, Mr. A simply pays Mr. B the difference between the contracted price and the actual price ruling at the date of the fulfillment of the contract. On the other hand, if the price of jute falls at the end of the period, Mr. B pays to Mr. A the difference.