futures question number 2

Discussion in 'Trading' started by z32000, Aug 4, 2007.

  1. z32000


    Can someone please explain how the futures market actually benefits say for example the corn industry.

    For example, say I was a farmer and I was able to round up about $10,000 worth of corn....

    if I sold or purchased corn futures.... how do I actually benefit from this? Can it save me from overgrowing corn in the fall? Right now, all I can think of futures is just a gambling pit. I'm not so clear as to how does it benefit the actual industry.
  2. LT701


    it alows you to adjust your net position without adjusting your physical position

    suppose you had all kinds of corn sitting on your farm, and you either didnt want to move it right now, or couldnt

    and for whatever reason, you wanted to not have so much, without actually moving the physical corn

    using futures, you could move to a net zero position, or any gradient of it
  3. The futures contract allows the farmer to "hedge" the actual physical commodity that he is growing in the ground and has yet to harvest.

    If he has commitments to sell his $10,000 worth of corn harvest to an end-user, but the yield from his crop is poor due to inclimate weather or insects, etc. - - - he is gonna wind-up being "short" of the amount of corn he has promised to his customer. With the futures contract, he has the ability to "hedge" the forward production of his crop and make good on his contract for 'X' amount of corn to be delivered to his customer. In similar fashion, the end-user can also "hedge" against the expected price rise due to poor yields by purchasing futures contracts so as to keep their cost down.

    In an opposite scenario, should the farmers harvest be unusually strong ( along with other farmers in the region ) yielding above average yields, he might then be concerned about corn prices falling due to oversupply of the commodity. He can use the future's markets to sell his forward production and "lock-in" a specific price before his crop is ever harvested; hence taking price risk and uncertainty out of his business.

    Commodities contracts allow the physical producer the ability to quantify risk, against a whole set of economic variables . . . from weather to war.

    It is by no means a "gambling" pit for the producer. It is a very specific tool used to take the UNCERTAINTY out of their business model. Just ask anyone from Cargil to International Foods, to Nabisco, to Folgers Coffee, to Valero Refining to Exxon-Mobil to Weyerhauser, to DuPont or PPG or any of the Airlines that need to "hedge" against aviation fuel prices.

    This is Basic Econ 101A.
  4. Futures are basically an insurance policy for the guys who use the stuff and the guys who provide/grow the stuff.

    If you worked for Kellogs and were in charge of producing Corn Flakes 6 months from now wouldn't it be nice to have the price of your corn locked up?
    If you were a farmer and about to plant a new crop wouldn't it be nice to know what you are going to get for it?
    That's a very simplified explanation.
  5. z32000


    i think i understood Bingoking's straight forward answer a little more.

    Say if the corn futures price is $20 for the December contract and the $15 for the September contract....

    considering that futures prices change constantly, who is to say that I, the farmer, might end up planting more corn thinking that the price of corn will go up in December but then just a few weeks before the price of corn will go down to the same price as September?

    If you say, how about I short corn now, so that I can still follow through with planting more corn right now and if the price dips...I the farmer will profit.

    Is this what you mean by using it as a hedge against losses? If so, how about if the price goes up? then I lose money too right? In both cases, I still have to try to for see the future.

    unless you are stating that if the price went up and shorted, the corn that I'm currently growing is going to be worth more, so there will be an equalibrum in price differences?
  6. My explanation is a rather oversimplified one to say the least.
    There are farmers who actually trade but I believe they use options to hedge their basically long position with the crop they have in the ground. December is the new crop month for corn (the crop that is in the ground right now). The current front month of Sept is corn from last year's crop. Here are a couple websites that may help: