What Is a Futures Market?
Let me explain directly: a futures market is an auction market where you and other participants buy and sell commodity and futures contracts for delivery on a specified future date. These futures are exchange-traded derivatives contracts that lock in the future delivery of a commodity or security at a price we set today.
You'll find examples of these markets in places like the New York Mercantile Exchange (NYMEX), the Chicago Mercantile Exchange (CME), the Chicago Board of Trade (CBoT), the Cboe Options Exchange (Cboe), and the Minneapolis Grain Exchange.
Originally, this trading happened through open outcry and hand signals in trading pits in financial hubs such as New York, Chicago, and London. But throughout the 21st century, like most other markets, futures exchanges have shifted to being mostly electronic.
Key Takeaways
Understand this: a futures market is an exchange where futures contracts are traded by participants interested in buying or selling these derivatives. In the U.S., these markets are largely regulated by the Commodity Futures Trading Commission (CFTC), with futures contracts standardized by the exchanges themselves.
Today, the majority of trading in futures markets happens electronically, with key examples including the CME and ICE. Unlike most stock markets, futures markets can operate 24 hours a day, giving you constant access.
The Basics of a Futures Market
To fully grasp what a futures market is, you need to understand the basics of futures contracts, which are the assets traded in these markets. These contracts are created by producers and suppliers of commodities to avoid market volatility—they negotiate with investors who agree to take on both the risk and reward of a volatile market.
Futures markets, or futures exchanges, are where these financial products are bought and sold for delivery at some agreed-upon date in the future, with the price fixed at the time of the deal. These markets go beyond just agricultural contracts; they now involve buying, selling, and hedging financial products and future values of interest rates.
Futures contracts can be made or 'created' as long as open interest increases, unlike other securities that are issued in fixed amounts. The size of futures markets— which tend to grow when the stock market outlook is uncertain—is larger than that of commodity markets and plays a key part in the financial system.
Major Futures Markets
Large futures markets run their own clearinghouses, where they generate revenue from the trading itself and from processing trades after the fact. Some of the biggest ones that operate their own clearinghouses include the Chicago Mercantile Exchange, the ICE, and Eurex. Other markets, like Cboe, use outside clearinghouses such as the Options Clearing Corporation to settle trades.
Most futures markets are registered with the Commodity Futures Trading Commission (CFTC), the main U.S. body in charge of regulating them. Exchanges are usually regulated by the nation's regulatory body in the country where they're based.
Fast Fact
Here's a quick point: futures market exchanges earn revenue from actual futures trading and the processing of trades, as well as by charging traders and firms membership or access fees to do business.
Futures Market Example
Consider this example: if a coffee farm sells green coffee beans at $4 per pound to a roaster, and the roaster sells that roasted pound at $10 per pound, with both making a profit at that price, they'll want to keep those costs fixed. The investor agrees that if the price for coffee drops below a set rate, the investor pays the difference to the coffee farmer.
If the price of coffee rises above a certain price, the investor keeps the profits. For the roaster, if the price of green coffee exceeds an agreed rate, the investor covers the difference, ensuring the roaster gets the coffee at a predictable rate. If the price is lower than agreed, the roaster pays the same price, and the investor takes the profit.
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