History of Commodity Futures

Commodities futures trading have evolved from the need for ensuring continuous supply of seasonal agricultural crops. In Japan, merchants stored rice in warehouse for future use. In order to raise case warehouse holders sold receipts against the stored rice. These were known as rice tickets.

Eventually such rice tickets became accepted as a kind of general commercial currency Rules came into being, to standardize the trading in rice tickets. The futures contract, as we know it today, evolved as farmers (sellers) and dealers (buyers) began to commit to future exchanges of grain for cash. For instance, the farmer would agree with the dealer on a price to deliver to him 5,000 bushels of wheat at the end of June. The bargain suited both parties. The farmer knew how much he would be paid for his wheat, and the dealer knew his costs in advance. The two parties may have exchanged a written contract to this effect and even a small amount of money representing a “guarantee.”

Such contracts became common and were even used as collateral for bank loans. They also began to change hands before the delivery date. If the dealer decided he didn’t want the wheat, he would sell the contract to someone who did. Or, the farmer who didn’t want to deliver his wheat might pass his obligation on to another farmer. The price would go up and down depending on what was happening in the wheat market. If bad weather had come, the people who had contracted to sell wheat would hold more valuable contracts because the supply would be lower; if the harvest were bigger than expected, the seller’s contract would become less valuable. It wasn’t long before people who had no intention of ever buying or selling wheat began trading the contracts. They were speculators, hoping to buy low and sell high or sell high and buy low.

In the early 20th century, advanced communication & transportation, centralized warehouses built in the principal markets, to distribute goods more economically, paved the way to expanded interstate and international trade. Agricultural commodities were the most commonly traded, but it led to the fact that a market can flourish for any underlying a long as there is an active pool of buyers and sellers.

Source: Scribd.com

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