Options Trading - Futures Trading Guide

INTRODUCTION TO FUTURES TRADING ::.::.:..

Origin of Futures Trading:

Along time ago, back in the days of Caesar, farmers and herdsmen needed a place to go to trade their commodities. Commodities, according to Webster Dictionary, is any useful thing that is bought and sold as an article of commerce. So, the farmers set up a marketplace in which to trade the "commodities". That was all well and good except for the problem of timing. Unfortunately, corn and other grains only are harvested at certain times of the year while the need for these grains was consistent year-round.

The traders began making what is now called a forward contract. A forward contract in the commodities market is a contract made by two people setup for the purchase and sale of a certain amount of a certain commodity for delivery at a certain time. It is considered a forward contract because delivery of the good occurs in the future. These forward contracts allowed farmers and herdsmen to guarantee a buyer for their grains and herds at a certain price and in the time frame that they needed. This went well for a while; but, as time went on, they incurred some problems.

For example, lets say Mark was a farmer of wheat back in the Caesarian times. And, he agreed to sell 5,000 bushels of wheat to Antony. Delivery was set for September. All is going great until a flash flood wiped out Marks entire crop. September comes around and Antony approaches Mark to collect his new wheat. Well, the price of wheat now has doubled and Mark does not have any wheat. Oh, did I also tell you that Mark skipped town. This poses a huge problem for Antony since he must now find someone else who has wheat, but also, he must pay double for it. Fortunately, this welching problem was corrected by the formation of "Guilds". The guilds were formed by the very traders using the markets. The guilds hold the entire group of users personally responsible. This allowed for confidence and insurance that the contracts made in the market would be backed by the full faith of the markets.

Upon the fall of the Roman Empire, the commodity markets followed in the same way. The "Dark Ages" brought a type of market, which had no centralized meeting place. A sort of nomadic group would travel around from village to village and buy or sell their supplies to those who needed them. Many times, traders would trick others upon the purchase of a pig. The buyer would choose the pig he or she wanted and the seller would reach under the table to grab a bag. Well, at the same time they were grabbing a bag, they would drop the pig and place a cat into the bag. What a surprise it must have been for the buyer to get home only to find out they would be the proud owner a cheap, useless cat instead of a pig. That is where the term, "Let the cat out-of-the-bag" comes from. After the dark ages, there was not a great deal of information recorded on the markets until the mid-1800.

The first futures contract (which is much like that of a forward contract) in our modern markets as we know of them today was for 2,000 bushels of corn traded in 1852. It was traded in a mid-sized town back then on the coast of Lake Michigan. Yes, that mid-sized town was Chicago, Illinois. A few years later, the Chicago Board of Trade was founded. Things have not changed much since then. Except for the chalk boards where the prices were written upon are now digital and the telegraph has been upgraded to the telephone, everything else is pretty much the same. Today, there are many boards of trade, Chicago, Kansas City, Minneapolis, Montreal, QB; New York City, London, Hong Kong and many other cities around the world.

You may wonder why do we need the markets other than to have a place for producers and consumers of these commodities to trade. Well, the producers and consumers set up these markets to relieve themselves of the risk of losing excessive amounts of money from price fluctuation. You may ask where does the risk go? Well, the answer is the speculator. A speculator is an individual or a group of individuals that trade in the markets purely for the opportunity to make money. They are the traders that carry the risk in order to attempt to profit off it.