Futures Market

What it is:

Futures markets are places (exchanges) to buy and sell futures contracts. There are several futures exchanges. Common ones include The New York Mercantile Exchange, the Chicago Board of Trade, the Chicago Mercantile Exchange, the Chicago Board of Options Exchange, the Chicago Climate Futures Exchange, the Kansas City Board of Trade, and the Minneapolis Grain Exchange.

How it works/Example:

A futures contract is a financial contract giving the buyer an obligation to purchase an asset (and the seller an obligation to sell an asset) at a set price at a future point in time.

The assets often underlying futures contracts include commodities, stocks, and bonds. Grain, precious metals, electricity, oil, beef, orange juice,and natural gas are traditional examples of commodities, but foreign currencies, emissions credits, bandwidth and certain financial instruments are also part of today's commodity markets.

There are two kinds of participants in futures markets: hedgers and speculators. Hedgers do not usually seek a profit by trading commodities futures but rather seek to stabilize the revenues or costs of their business operations. Speculators are usually not interested in taking possession of the underlying assets. They essentially place bets on the future prices of certain commodities. Speculators are often blamed for big price swings in the futures markets, but they also provide a lot of liquidity to the futures markets.

Futures exchanges do not set the prices of futures contracts or their underlying traded commodities. Rather, supply and demand determines the prices. But two things in particular ensure the stability and efficiency of futures markets: standardized contracts and the presence of clearing members. Standardized contracts mean that every futures contract specifies the underlying commodity's quality, quantity and delivery so that the prices mean the same thing to everyone in the market. A commodity from one producer is no different from another and the buyer knows exactly what he's getting. Clearing members manage the payments between buyer and seller. They are usually large banks and financial services companies. Clearing members guarantee each trade and thus require traders to make good-faith deposits (called margins) in order to ensure that the trader has sufficient funds to handle potential losses and will not default on the trade. The risk borne by clearing members lends further support to the stability of futures markets.

The Commodity Futures Trading Commission (CFTC) regulates commodities futures trading through its enforcement of the Commodity Exchange Act of 1974 and the Commodity Futures Modernization Act of 2000. The CFTC works to ensure the competitiveness, efficiency and integrity of the commodities futures markets and protects against manipulation, abusive trading and fraud.

Why it Matters:

The world of commodities and the futures markets on which they are based are complex, fascinating, and have a profound effect on economies and average citizens around the world. Changes in commodity prices can affect entire segments of an economy, and these changes can in turn spur political action (in the form of subsidies, tax changes, or other policy shifts) and social action (in the form of substitution, innovation, or other supply-and-demand activity).

Most buyers and sellers trade commodities on the futures markets because many commodity producers, especially those of traditional commodities like grain, bear the risk of potentially negative price changes when their products are finally ready for the market. In general, however, the liquidity and stability of the commodities exchanges helps producers, manufacturers, other companies, and even entire economies operate more efficiently and more competitively.
 

Best execution refers to the imperative that a broker, market maker, or other agent acting on behalf of an investor is obligated to execute the investor's order in a way that is most advantageous to the investor rather than the agent.