Where are futures traded

Where are futures traded

Futures, like stocks, are traded on exchanges. A commodity exchange is an organized market where traders meet to buy or sell various futures contracts. The exchange may be a physical location, like the Chicago Mercantile Exchange, or it may be an electronic gathering place such as GLOBEX. Either way, the exchange acts as an important part of the futures industry by:

• Providing an organized location (physical or electronic) for trading futures
• Regulating the trading practices of their members
• Gathering and transmitting price information
• Gathering and governing commodities traded on the exchange
• Supervising warehouses that store the underlying commodities
• Providing a means for settling disputes between members

History of the Futures Market

It is helpful to begin a discussion on the futures market with a historical sketch. Commodity markets have existed for centuries around the world because producers and buyers of commodities, such as rice, wheat, oil and other items have needed a centralized place to trade. In those days, cash transactions were most common, but occasionally a "forward" type arrangement was also made - deals to deliver and pay for something in the future at a price agreed upon in the present. There are records, for example, of "forward" agreements related to the rice markets in seventeenth century Japan; most scholars agree that forward arrangements actually date back much farther in time.

The immediate predecessors of futures contracts were "to arrive" contracts. These were simple agreements to purchase designated goods when they arrived by ship, and they were used for centuries when shipping was the primary mode of international trade.

The first organized grain futures trading in the U.S. began in places such as New York City and Buffalo, but the development of "modern" futures, which are a unique type of forward agreement, began in Chicago in the 1840s. With the construction of the railroads, Chicago began to emerge as a center for transportation between Midwestern producers and East Coast population centers. The city was a natural hub for trade, but the trading that took place was inefficient and unorganized until a group of Chicago-based businessmen formed the Board of Trade of the City of Chicago in 1848. The Board was a member-owned organization that offered a centralized location for cash trading a variety of goods, as well as trading of forward contracts. Members served as brokers who facilitated trading in return for commissions.

As trading of forward contracts increased, the Board decided that standardizing those contracts would streamline the trading and delivery processes. Instead of individualized contracts, which took a great deal of time to negotiate and fulfill, people interested in the forward trading of corn at the Board, for example, were asked to trade contracts that were identical in terms of quantity, quality, delivery month and terms, all as established by the exchange. The only thing left for traders to negotiate was price and the number of contracts.

These standardized forwards were essentially the first modern futures contracts. They were unlike other forwards in that they could only be traded at the exchange that created them, and only at certain designated times. They were also different from other forwards in that the bids, offers and negotiated prices of the trades were made public by the exchange. This practice established futures exchanges as venues for "price discovery" in U.S. markets.

In contrast to customized contracts, standardized futures contracts were easy to trade since all trades were simply re-negotiations of price, and they usually changed hands many times before expiration. People who wanted to make a profit based on a fortuitous price change, or alternatively, who wished to cut mounting losses as quickly as possible, could "offset" a futures contract before expiration by engaging in an opposite trade: buying a contract which they had previously sold (or "gone short"), or selling a contract which they had previously bought (or "gone long").

The usefulness of futures trading became apparent, and a number of other futures exchanges were established throughout the country in the decades that followed. The Chicago Butter and Egg Board was founded in 1898 and evolved into the Chicago Mercantile Exchange (CME) in 1919. Futures exchanges also opened in Milwaukee, New York, St. Louis, Kansas City, Minneapolis, San Francisco, Memphis, New Orleans and elsewhere. Chicago, however, became the most influential and predominant location for futures trading in the U.S.

In recent years, the commodities exchanges have experienced tremendous change by way of mergers and acquisitions. Most notably, the Chicago Mercantile Exchange has redefined itself as the Chicago Mercantile Exchange Group - a conglomeration of the Chicago Mercantile Exchange, the Chicago Board of Trade, and the New York Mercantile Exchange. Otherwise know as the "Merc," the Chicago Mercantile Exchange Group also controls the world's largest electronic futures exchange: Globex.

In addition to the Merc, there are many other commodity exchanges both domestically and around the globe. The industry is in a state of significant growth, and change is announced almost daily. As of this writing here are some other exchanges you may come across:

Kansas City Board of Trade

A commodity futures and options exchange that specializes in hard red winter wheat - the principal ingredient of bread.

Chicago Climate Exchange

A relative newcomer to the futures industry, the Chicago Climate Exchange is North America's only voluntary, legally binding greenhouse gas (GHG) reduction and trading system for emission sources and offset projects.

Intercontinental Exchange

An electronic based marketplace which trades futures and over-the-counter (OTC) energy and commodity contracts as well as derivative financial products. While the company's original focus was energy products, recent acquisitions have expanded its activity into the "soft" commodities, foreign exchange and equity index futures.

One Chicago

A subsidiary of the Chicago Mercantile Exchange, One Chicago is the home of single stock futures (SSF's), which are futures contracts with the underlying asset being stock.

Futures trading is also growing around the world with many notable exchanges including Canada's Montreal Exchange, Britain's London Metal Exchange, Eurex, and many more.

How futures are traded on exchanges

Trading at the futures exchange is conducted in two ways: an open outcry format and the electronic trading platform.

Open Outcry

The open outcry method consists of floor traders standing in a trading pit to call out orders, prices, and quantities of a particular commodity. Traders on the floor of the exchange wear different color jackets to indicate their position and affiliation. In addition, complex hand signals (called Arb) are used. These hand signals were first used in the 1970s. The pits are areas of the floor that are lowered to facilitate communication, sort of like a miniature amphitheater. The pits can be raised and lowered depending on trading volume. To an onlooker, the open outcry system can look chaotic and confusing, but in reality the system is a tried and true method of accurate and efficient trading.

Electronic Trading

Approximately 70 percent of total futures volume is conducted via electronic trading platforms. Fully electronic trading systems allow market participants to trade from booths at the exchange or while sitting in a home or office thousands of miles away.