Futures Trading – Definition, History and Types

Futures trading are the trading of futures contracts, which gives the holder the ability to buy underlying products for a predetermined price after a definite period of time. These contracts are created mostly for hedging the price uncertainty at the time of product delivery. Futures trading differ from spot trading, in which the trades are completed on the spot. The delivery time of the product is mostly 3 months or 6 months. Futures contracts can be grouped into two broad categories as commodity futures and financial futures.

The trading futures contracts begun in 17th or 18th century in Japan and Holland for agricultural products like rice and wheat. But the first organized futures trading started in Chicago, United states in 1840. In 1848, the first centralized futures trading market came in to being in Chicago called Board of Trade of the City of Chicago, which allowed both spot trading and futures contract trading. The Board of Trade of the City of Chicago later modified its name as Chicago Mercantile Exchange (CME).

In 19th century the products available for futures trading are common agricultural commodities like wheat, rice, oats etc; also some live stocks and meats. Most of these products are traded across US, from western agricultural lands to eastern populated lands. Later more products such as gold, silver, crude oil, natural gas, heating gas, etc were also become available for trading. With the development of the market the products increased to stock futures and stock index futures. In 1971, with the ending of currency gold standards, CME introduced financial futures for the first time, which soon became the most traded futures item. In 1987 electronic trading of futures started and futures contracts become available to everyone around the world.

All futures contracts are guaranteed by clearing houses and have unalterable contract specifications including delivery time and price of the underlying product. Although both names, futures contracts and forward contracts, are used alternatively, they differ in the trading style. Forward contracts are traded OTC (over the counter) though broker-dealer interactions, which involve price bargaining. But futures contracts are traded by open outcry of screen in public domain or simply through centralized futures markets. Remember unlike options, in futures trading it is mandatory to own/deliver the underlying product at the end of the contract period.

As discussed earlier, there are a variety of products available for futures trading, which are named after the underlying product they have. The most common type of futures is the commodity futures for agricultural, metal, energy, meat and live stock commodities. The financial futures or money futures are the futures contracts which have bonds, treasury notes, and other interest-based assets as underlying product. Stock futures have individual stocks are underlying product, where as stock index futures are meant for hedging stock market fluctuations as a whole. Like wise, currency futures are for individual currencies and index futures are for one group/whole market currencies. Although not a future contract, futures options are also a familiar product which gives the holder the option to buy a contract for a specified price at a specific time.