how futures works

Discussion in 'Trading' started by z32000, Aug 27, 2007.

  1. z32000


    I'm still trying to figure out what is the process of using futures for hedging purposes for those that produce commodities...say for example, a corn farmer...

    1. If I predict the demand of corn will go down in December, does a corn farmer actually grow less corn and does he literately go online and short the corn futures? What do they specifically do in this situation?

    2. When some of these commodities are these farmers literately go to the exchange and drop off say corn and hogs there?

    3. If futures aren't much more different pricewise than the underlying stock, what good is it? Say if I, the farmer, thought corn demand was coming down in a few months, even if I shorted the corn futures...i still have to wait till the contract ends to make the most of my prediction....would it be no different if I just shorted the underlying stock now since it should go down by that time as well. Don't traders already consider future predictions when pricing a current stock?
  2. no. 22

    no. 22

    The futures for a corn producer and corn consumer (ethanol maker, Kellogs, etc) are a way to reduce risk. The risk to the farmer is that the price of corn may go down. The risk to the consumer is that the price of corn may go up. The futures are used by those people to smooth out price fluctuations.

    Price speculators are a different story.
  3. gnome


    1. Producers don't usually hedge unless they believe the price will fall. Then they might "forward sell" futures contracts and deliver their production to a contract buyer at a later date. The farmer would be speculating that the price he sold for today would be higher than he could get at delivery time.

    2. Yes, the commodity is delivered somewhere.

    3. Stock indices are the same... contract sellers are betting the price they get today will be higher than later. However, there is no delivery. Accounts are settled in cash, one way or another.
  4. A real simple example is how Southwest Airlines bought fuel futures when Oil was down in the $50-$60 range, and jet fuel was cheap. By saving the big increase in market price, they were able to charge the same for airline tickets, but kept a higher profit margin. Of course, this can go against you as well, but since you're going to be using the fuel one way or another, you can run your business knowing what your fuel costs will be for the next 12 months.

  5. gnome


    A failed example of producers hedging (forward selling) was in gold several years back. Some gold produces were convinced the price of gold was going nowhere or down and forward sold YEARS of production at $300-$350/oz.

    They still had to deliver at the agreed upon price even though gold had rallied to $500 and beyond.
  6. go to the commodity exchanges websites. Hedging and other principles are documented better than you can learn from forum posts