Why is it that every time someone mentions futures trading someone comes along to drop the farmer's crops example, do y'all really have no other examples?
What percentage of futures trading is on farmers crops?
What about the crops they destroy because they would be less profitable? Does the protection against monetary risk outweigh starving people to death?
How well will it work if we create unsustainable land that the farmers can no longer grow crops on?
I don't have a percentage for you but agriculture-related futures make up a non-negligible amount of overall trading. It's not just some artificial example. Agricultural futures were also the first futures, and much of today's trading infrastructure was built around agricultural futures. So that's probably part of why it is such a common example.
They are far from the only example. Airlines use futures to hedge against fluctuations in fuel prices. Manufacturers use futures to hedge against fluctuations in the price of input materials. International businesses use FX swaps to hedge against currency fluctuations. Borrowers use interest rate swaps to hedge against interest rate rises. Investment funds (including pension funds and sovereign wealth funds) use options to hedge against drastic movements in asset prices.
I don't really understand your other questions. The use of derivatives in agriculture does not, on balance, result in fewer crops being produced. On the contrary, by allowing farmers to protect themselves against various risk, derivatives markets allow farmers to safely invest more money in production, and reduces the risk of farmers going bankrupt (bankrupt farmers don't produce many crops). Food would almost certainly be more scarce and more expensive if farmers did not have access to the financial markets.
Because farmers have been using futures contracts (traded on an exchange) since 1859.
And technically, futures are a more standardized tool than forwards are, hence the talk about futures all the time. [1] For reference, forwards have been used forever, and used for all sorts of commerce. [2]
We take for granted that you can pull out an iPhone and buy your favorite stock in seconds, but for most of history, nobody could even imagine that. That the modern world even exists is because of forwards and futures. The ancient world was able to grow and expand because of forwards.
The one goal of future contracts is for producers and consumers to be able to make deals before that production and consumption happens. Those are the primary dealers there, and I don't really remember where I got statistics, but AFAIK, they are about 10% of the volume.
On top of those primary deals, a lot of people pile up making bets on secondary deals. Those are the people going for "hey, a lot more farms are growing rice this year, I bet its price will fall". They are very welcome because they not only stabilize the prices on those markets, but they also provide short-term money to make the deals flow more homogeneously. Without them, making deals on those markets would be a profession by itself (as it was).
Now, there exist people making bets on the results of the bets of the secondary market. That is a different market. At some point it's clear that this becomes toxic, but nobody seems to agree on what point exactly.
> What about the crops they destroy because they would be less profitable?
You mean farmers getting bankrupt? You seem to be misunderstand, because the main reason farmers love the futures market is because it lowers their risks.
> How well will it work if we create unsustainable land that the farmers can no longer grow crops on?
Well, surely if you go and kill everybody, there will be nobody losing money on those markets.
> What about the crops they destroy because they would be less profitable?
To clarify this point specifically, food self sufficiency is considered a national security issue.
Consider the situation where a hostile country floods your market with cheap food products (below cost) until your country's farms go bankrupt due to an inability to compete. Once you stop producing food of your own, you give significant power to whoever controls your food supply.
This is a large part of why agricultural subsidies exist. And yes, sometimes it means paying farmers to let crops rot on the vine in order to not cause market gluts. That is an entirely different situation from futures and hedging, which in any sane market match supply and demand (with the result of minimizing waste).
Not necessarily, if they can produce the crops more cheaply. Since each country ideally wants to secure it's own food supply, it's inevitable that many countries will find themselves subsidizing local production that would otherwise disappear in a competitive international market.
Additionally, hostile countries do not need to flood markets sustainably if the goal is simply to hollow out food production in the target country before taking more overtly hostile (i.e. military) actions.
Because it's an example you can use to explain a forward contract, which is easily understandable as a form of hedging risk. Vast amounts of the value of crops are hedged, either through forwards, futures or derivatives. Crops aren't destroyed because of hedges (in the financial sense). Indeed, the whole point is to ensure you don't need to, because you've hedged the value of your crop.
I get where you're coming from, and there's a lot which is not great in farming, but hedging values isn't one of those areas.
>Why is it that every time someone mentions futures trading someone comes along to drop the farmer's crops example, do y'all really have no other examples?
Because it was created by them, for that very purpose? Futures Contracts. Chicago Mercantile Exchange. Up until 1971 future contracts were ONLY for agricultural goods.
You’re right but in America we use the agricultural example as it was a big shift in our market thinking. I didn’t know about metal futures but I did know about Dutch and how they created futures and securities. I believe the Dutch East India Co to be ahead of its time and because of world politics (and war) it didn’t survive and was nationalized. A lot of papers about our CME here in the states talks about it. I’m not an expert but I do know we use the agri example because it’s one most would be familiar with since it was a somewhat recent addition.
It’s not just farmers. It’s useful for anything that involves future delivery of a good that could have a variable price or production.
A mining company would sell gold futures under the expectation that they will mine a known quantity of gold. They trade the risk of price fluctuations to match against their known liabilities (e.g. labor or depreciation of equipment costs).
Now replace “gold” with lithium (for electric car batteries) and you can create the greenwashed story that you want to hear.
The website gives the gold mine example. Farmers and gold miners often have to weigh taking on a loan to get them through next season. They want a fixed rate of return to determine if the loan is worthwhile.
> Why is it that every time someone mentions futures trading
They didn't just mentioned, they had an outsider negative take on it.
The best way is to respond with simple examples.
> What about the crops they destroy because they would be less profitable? Does the protection against monetary risk outweigh starving people to death? How well will it work if we create unsustainable land that the farmers can no longer grow crops on?
How does futures trading cause these negatives? If anything, trading reduces these risks. Countries with markets have large bounties as opposed to those that don't.
Because that’s what futures are for? Consumers and producers of commodities want to lock in prices to lower the risk of price fluctuations in the future.
Other examples are _all_ commodities markets like mining, logging, etc.
Of course public company share futures are inherently abstract, but they serve similar purposes, just not to a particularly similar party, depending on your perspective (of ownership, operation).
Not sure why this person is getting downvoted, these seems like fair questions.
Edit: Now get why it is downvoted, but it's fair to note that farmers represent a small (10% from what I gather here) portion of futures, so I don't know how reprensentative they are.
There is a societal benefit that comes with individuals internalizing their own costs of risk. Treating society like it's in an economic womb while Mother Finance shields it from the world of worries rewards ignorance and in my opinion accelerates us toward the world depicted in Idiocracy.
It is nice as a purchaser of such securities that you can build things more quickly than usual and transfer worry to someone who is willing to be worried for you. However I don't believe the SEC financial highway patrol has enough cruisers or sophistication to pull over enough abusers to deter the disproportionate fraud that increasingly arcane financial instruments create.
The costs of a few bad actors building piles of money illegitimately do not show themselves immediately. They pop up slowly, in dark money investments in destabilizing elections, funding of war criminals, market manipulation, etc. The societal cost of a charlatan having several lifetimes worth of an honest person's influence are grave and not to be laughed off.
I get why farmers do it but what's the societal benefit of letting a rando like me buy and sell (i.e. make bets on) such contracts? Do farmers really prefer that random people do this?
Theoretically, the societal benefit of lettings randos buy and sell contracts is that there is (a) better price discovery and (b) better liquidity. There are probably theoretical counterarguments to both of those points, but it's hard to see alternative systems that provide either or both those features.
At a basic level, obviously thee needs to be someone assuming the price risk from the farmers, and those people will obviously need to be compensated.
I buy that there's some benefit, but I don't buy that it's significant. And I don't see any reason why I should believe this provides a net benefit to society. Sure it saves the original parties some money, but then a bunch of unrelated parties come in and siphoning money from the existing parties. Why should I believe this is net-benefiting society?
The more something trades, the more likely we will have the right price. When things don't trade as much, we don't actually know what that thing is worth.
This concept is a benefit to society as many things are interconnected and correlated, so the more accurate we can quickly find the current price (and expected future price) the more we can evaluate value.
(Also, they aren't "siphoning money" really it's "value" because the contract isn't actually money)
Just because you've improved the accuracy of a price for something, that doesn't mean whatever you're doing to achieve this is a net benefit to society, right? Surely the idea that this logic doesn't follow isn't weird?
Is the idea that society gets a net benefit from price distortions like minimum wage, subsidies, taxes, etc. also "weird"? These also make it hard to discover the "right price" for goods, therefore it's... weird to have them?
My point about being "weird" was related to this bit:
> but then a bunch of unrelated parties come in and siphoning money from the existing parties.
I think you are trying to argue that markets mean that the value of a purchased contract changes, and that's only if you want to sell the contract again. If you buy the contract you'll get delivery of what you bought at that price? the market moving only affects you if you want to sell again. If I buy a 2009 used dodge charger with 100k miles for 10k, and then the next day someone sells another 2009 dodge charger with 100k miles for 9k, are those unrelated parties siphoning money away from me?
You could go straight to your local wheat farmer and cut a deal directly with them, but they are gonna say "what's the going rate for wheat" and call some friends and look at market data to determine if they want to accept your deal or not.
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If you believe that futures markets are harming society, then what is your proposed solution as to how a buyer and seller should agree on a fair price for wheat?
In general/basics/origins, farmers only want to sell futures, because they actually have (intend to have) the commodity for physical delivery, and do want to physically deliver it.
So who is on the buy-side? Exclusively supermarkets/distributors, while exclusively farmers sell? I suppose that could work, but I assume it would quickly regress into tight relationships like we have (probably regionally variable) for smaller market's, like most vegetables (vs grain) where as I understand it it's largely a direct relationship with the buyer - you probably still sell a future contract, but it's not via a central market and it is 'farm x will deliver to buyer y', i.e. a pre-order if you will, not really a commodity.
And as others say, price discovery, liquidity. What harm does completely open (no obligation) do? And maybe you eat a lot of potatoes and want to lock in the price today. (Or more seriously maybe you're a big baker, but not big enough to be buying direct from farm, your miller is. So grain price affects you, but ypu can't directly control/choose when to take it. Secondary grain futures allow you to hedge risk of it moving against you. In turn this means lower prices or lower risk of shock price increase to your consumers.)
Farmer agrees to sell an agricultural commodity to a grocer, for a price fixed now, with delivery after the harvest. Assume price falls a lot, and then the grocer goes bust. Ouch! Then the farmer must instead sell on the open market, at the lower price, and so becomes unable to make the payments on the mortgage on the tractor. Ouch ouch!
The farmer did want the price certainty that allows the risk of being more leveraged (tractor mortgage). But the farmer was not the optimal person to hold the credit risk of the grocer.
And the farmer might have sold without the intent to deliver. It might be that the delivery specification, or location, or whatever, isn’t perfect for the farmer. But if the farmer is confident that the prices will move together, then it still works.
It creates the market and should thus create the best possible price. Think of any speculation as a voting system with proof of stake.
Problems always appear when market participants try to affect reality to increase their odds, like shorting a position and then releasing some ugly news.
It's doubtful that farmers care about you in particular. However, in general, the societal benefit should be like a loan, like insurance, or both, depending on what it is.
Loans are useful and necessary because businesses need to buy things before they get paid. It can't all be done using Kickstarter! Farming works this way.
Insurance is useful because you get paid when something bad happens to you. On a day when you're glad that you had insurance, it means someone else lost a bet.
Buying insurance you don't actually need is kind of dumb because you'll lose on average, but people do sometimes win in casinos, too. Selling insurance when you can't afford to lose is risking disaster, but sometimes people get away with that too.
I don't follow. If the goal is insurance then why not just have... something more like insurance? Like when you buy insurance for your car or home? We don't let randos buy options on the average Joe's mortgage or car loan and claim it helps price discovery or liquidity, right? Or is it the case that even I can do that and I'm just out of the loop?
To answer your question directly, there are active markets where insurance policies are effectively "traded" like this (reinsurance and retrocession and the Lloyds market). A single policy with sufficient limits absolutely does get syndicated out and bought like this. For smaller policies they get bundled up. But they're professional markets where participants must be regulated because insurance regulation is how we mitigate counterparty credit risk on insurance policies.
But "like insurance" I think was meant as a broader term. Traditional insurance contracts look a bit like options. But forward purchases or sales are also often used as "insurance". The big gain is that purely cash settled contracts (or contracts where cash settlement is possible as a result of sufficient market liquidity existing to allow closing a position before physical settlement) can be used for risk mitigation in other ways which offer much better liquidity and better cost-efficiency in the right markets.
A good real world example is oil price hedging. An airline might want to mitigate the risk that their future cost of jet A-1 goes up. On the other hand, an oil producer might want to mitigate the risk that their future sale price of a particular blend of their crude goes down. Instead of using insurance or entering into bilateral forward contracts, both can trade futures or options on a standardised crude (which neither of them is ever planning to physically deliver or take delivery of[0]). The contract they are trading will not be a perfect hedge for either of them, but it will mitigate their risk significantly. In fact if they are both large enough, bilaterally the liquidity available to them would likely be insufficient to mitigate the same amount of risk.
Having a "single", transparent price also brings some other benefits beyond simple liquidity. For example, it enables several ways to manage counterparty credit risk which would otherwise be unavailable (daily margining, use of central counterparties or clearing, etc).
[0] although the contract might enable an oil producer to make physical delivery of their own blend with a price adjustment
I don't know, but one reason might be history. Modern insurance companies are pretty recent. Before the 1920's, there were mutual-aid societies. Commodities trading is ancient.
But they also do different things:
You need insurance companies for one-off risks. Someone has to go see the house and say, "yep, it burned down." Also, we don't let people bet on other people's houses burning down for good reason.
Other risks are more impersonal, like "what if this company I bought a bond from goes bankrupt" or "what if the price of corn drops in half" or "what if the price of oil doubles." There are lots of people and companies who might want to hedge against those, not just the owner of the property.
Society allows the people to trade futures, but makes it difficult. US brokers seem to make it very easy for “randos” to own equities, but difficult to trade futures. Recently, when I wanted to trade a one-by-one call spread on a commodity future (not saying which) via Interactive Brokers, the required initial margin would have been eight times my maximum possible loss. Bonkers! Hence trade not done.
And what would you rather happen? That you were prohibited?
As others have said, your counterparty won’t know who you are: hedge fund; commercial hedger; rando — unknown.
Provide liquidity. Speculators are trying to make profit, but their existence is important to make sure the farmers are correctly priced.
Do farmers prefer that? Yes, the larger the futures market, the price of selling futures will be closer to optimal. If the market is illiquid, farmers often have to sell futures at a lower prices to market makers.
Many 'randos' like you have lots of money and would happily buy the contract in the hope that they win out, and would be not bummed out completely if they lose, unlike the farmer, for whom such events could be existential.
[0] https://www.ers.usda.gov/webdocs/publications/99518/eib-219....
[1] https://emp.lbl.gov/publications/primer-electricity-futures-...