| Who Trades Futures? |
| Written by Aaron Adam | |
HedgersHedgers are investors who have an interest in the underlying asset being traded (gold, oil, metal, farm products, etc.). Speculators are investors who are looking to profit by predicting market fluctuations and opening a derivative contract -- or trading the asset on paper, in popular parlance. Typical hedgers include people involved in a variety of businesses, including commercial farming. Market values for various farm products, including corn, wheat and other products are in constant flux as the supply and demand for these products rises and falls, with sporadic big moves up or down. Based on existing prices and predictions made around harvest time, a commercial farmer may determine that he should plant corn one season. However, forecasted prices are only predictions, and there is no surety that they'll come true. Once a farmer decides to plant corn, he is stuck with that corn for that growing season, regardless of how price may change. If corn prices rise between planting and harvest, he'll reap a big profit. If prices plummet, he could face heavy losses. To offset this risk, the farmer could sell corn futures contracts at planting time, which locks in the price of corn at the time the contract is sold. The futures contract obligates him to deliver a set number of bushels of corn at a specified future date for the specified price. While the farmer gives up the opportunity to make a big profit at harvest time, he also eliminates the chance that he'll be ruined by a large dip in the corn price. SpeculatorsOn the other hand, speculators seek to profit from rises and falls in the price of the underlying commodity. A speculator who believes a commodity's price will increase will buy futures contracts on the premise that he'll be able to sell them later for a higher price. In trading parlance, this is called going long. A trader who thinks a commodity's price will decline will sell futures contracts, hoping to buy identical commodities later at a decreased price. This is called going short. Because money can be made from buying or selling, futures trading that is particularly attractive to investors. Both hedgers and traders rarely take delivery of their contracts. Most speculators have no desire to take or make delivery of 10,000 barrels of oil, or 2,000 bushels of corn. Most speculators take their profits and their losses by selling or buying offsetting futures contracts before the expiration date of their futures contract. Selling off a contract that was purchased earlier closes out a futures position in pretty much the same manner that selling off 1,000 shares of a stock liquidates the prior purchase of 1,000 shares of the same stock. A futures contract that was sold earlier can be liquidated by offsetting it with the purchase of another futures contract. The trader's loss or profit is in the difference between the buying and selling price. Delivery rareHedgers also rarely take or make actual delivery. Most hedgers instead find it more convenient to close out their positions, and if they profit, to then use that money to offset any adverse price change transpiring in the cash market for the underlying asset. When delivery does occur, it's in the form of a receipt or voucher that documents the holder's ownership of the underlying asset. Delivery does occasionally happen, and the provision exists primarily to help ensure that futures prices accurately reflect the value of the underlying asset in the cash market when the contract expires. This convergence is important to the purpose of the futures market, which is to help set realistic prices and to allow a means to obtain protection against adverse changes in cash market prices. |
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