Legal Definitions - futures market

A futures market is a specialized financial marketplace where participants buy and sell standardized agreements called "futures contracts." These contracts obligate the buyer to purchase, or the seller to sell, a specific quantity of an asset (such as a commodity, currency, or financial instrument) at a predetermined price on a specified date in the future.

The primary purposes of a futures market are to facilitate price discovery for various assets and to provide a mechanism for risk management, known as hedging. Participants can also use these markets for speculation, aiming to profit from anticipated price movements.

• Example 1: A Coffee Producer Hedging Against Price Drops

  A large coffee plantation in Brazil expects to harvest a significant crop in eight months. The owner is concerned that global coffee prices might fall by then, reducing their potential earnings. To mitigate this risk, the plantation owner enters into a futures contract in the futures market to sell a specific volume of coffee beans at a price agreed upon today, for delivery in eight months. This action allows the owner to lock in a selling price for a portion of their future harvest, providing financial stability regardless of what the spot market price for coffee might be closer to the harvest date.

• Example 2: A Bakery Managing Wheat Costs

  A national bakery chain relies heavily on wheat flour for its products. The company's profit margins are sensitive to the fluctuating price of wheat. To ensure predictable costs for its ingredients, the bakery's procurement team might purchase wheat futures contracts in the futures market for delivery several months in advance. By doing so, they secure a price for a portion of their future wheat supply, protecting the company from unexpected increases in wheat prices that could otherwise impact their production costs and profitability.

• Example 3: An Investor Speculating on Technology Stock Index

  An individual investor believes that a particular index tracking major technology stocks will experience significant growth over the next six months. Instead of buying shares in all the individual companies within the index, which would be costly and complex, the investor decides to purchase a futures contract tied to that technology stock index in the futures market. The investor's goal is not to take physical delivery of the underlying stocks but rather to profit by selling the futures contract at a higher price before its expiration date, if the index indeed rises as predicted. This demonstrates using the futures market for speculation on the future direction of a financial market.