4
A Complete Guide to the Futures mArket
The essence of a futures market is in its name: Trading involves a commodity or financial 
instrument for a future delivery date, as opposed to the present time. Thus, if a cotton farmer 
wished to make a current sale, he would sell his crop in the local cash market. However, if the 
same farmer wanted to lock in a price for an anticipated future sale (e.g., the marketing of a still 
unharvested crop), he would have two options: He could locate an interested buyer and negotiate 
a contract specifying the price and other details (quantity, quality, delivery time, location, etc.). 
alternatively, he could sell futures. some of the major advantages of the latter approach are the 
following:
 1. The futures contract is standardized; hence, the farmer does not have to find a specific buyer.
 2. The transaction can be executed virtually instantaneously online.
 3. The cost of the trade (commissions) is minimal compared with the cost of an individualized 
forward contract.
 4. The farmer can offset his sale at any time between the original transaction date and the final 
trading day of the contract. The reasons this may be desirable are discussed later in this chapter.
 5. The futures contract is guaranteed by the exchange.
Until the early 1970s, futures markets were restricted to commodities (e.g., wheat, sugar, 
copper, cattle). since that time, the futures area has expanded to incorporate additional market sec-
tors, most significantly stock indexes, interest rates, and currencies (foreign exchange). The same 
basic principles apply to these financial futures markets. Trading quotes represent prices for a future 
expiration date rather than current market prices. For example, the quote for December 10-year 
T -note futures implies a specific price for a $100,000, 10-year U.
s. Treasury note to be delivered 
in December. Financial markets have experienced spectacular growth since their introduction, and 
today trading volume in these contracts dwarfs that in commodities. 
nevertheless, futures markets 
are still commonly, albeit erroneously, referred to as commodity markets, and these terms are 
synonymous.
 ■ Delivery
shorts who maintain their positions in deliverable futures contracts after the last trading day 
are obligated to deliver the given commodity or financial instrument against the contract. similarly, 
longs who maintain their positions after the last trading day must accept delivery. in the com-
modity markets, the number of open long contracts is always equal to the number of open short 
contracts (see section V olume and Open 
interest). Most traders have no intention of making  
or accepting delivery, and hence will offset their positions before the last trading day. (The 
long offsets his position by entering a sell order, the short by entering a buy order.) 
it has been 
estimated that fewer than 3 percent of open contracts actually result in delivery. some futures 
contracts (e.g., stock indexes, eurodollar) use a cash settlement process whereby outstanding long 
and short positions are offset at the prevailing price level at expiration instead of being physically 
delivered.