Okay, say we have grain producers A, B, and C. They are looking to make contracts for December 2013 Wheat for a certain portion of their grain. A sets his contract at $5 per bushel, B at $6, and C at $7. So, the average price between the producers is $6 per bushel. Is that more realistic? Or would a single grain producer set hundreds or thousands of contracts at various prices for the December '13 contract? Even so, one could average those prices and still arrive at the "Average Contract Expiration Price". Wouldn't such a price be immensely useful, especially as the expiration date of a contract approaches?
A,B,C don't necessarily sell all their crop in advance. Even if they wanted to do so, futures contract implies a quantity and A,B,C don't know exactly what their crop quantity will be, so they can't sell all their crop in advance in the futures market. Yeah that's right, if you got only 3 producers and they sell everything on a forward contract, the price can almost be known in advance, but there are multiple producers in multiple countries , with crops at different time of the year, stocks, weather unknowns... and that's why there is a standardized market so that supply meets demand at anytime whatever the conditions are.
Okay, thanks. But that raises another question: What role does the speculator play? Let's say that the farmer sets up his contracts for the next year or so. All the wheat from that farmer has a set price. Now imagine all wheat farmers participate in the wheat market in a similar way. Then why is forward delivery - in other words, wheat that is part of the futures market - subject to all that fluctuation?
So, forward delivery prices are known. Then spot trading of surplus crop is what creates the price fluctuations? That can't be right. That would mean that what we're trading isn't Futures Contracts, it's contracts on what is being sold right here, right now. We are trading June wheat and December corn or whatever. So, what's the deal with the price fluctuation? Sorry, maybe I'm just a total retard. Anyway, I'll get back to reading that book Lornz mentioned. If I find the answer to these questions, I'll write it up.
I believe you and Tradator got it wrong. No one particular entity sets the price. Futures market deals with forward contracts. Spot market deals with cash. By the time the futures contract expires, it's settled price will be identical to the spot price. More importantly, the sole business of the grain producers (viz. farmers) is to "hedge" against any unforeseen events that might affect prices by the time they bring their products to the market. That is, they use the futures market as an insurance. It's never about directly setting their own prices.
Okay, then the whole concept is often explained incorrectly. I've read passages similar to the following several times: So, now my question is to understand how farmers use the market to hedge themselves against unforseen events. I'm sure the methods used by grain producers is very complex . =\
Damn, I have a few questions for you: - What will the producer be paid at the end of the contract ?The price they agreed on or the settlement of the futures ( spot price )? - What does the average weighted price during the life of the futures has to do with the settlement of the futures ( spot price )? You need to change your perspective on a market for simplicity. First there is a cash market and then around people decide to deal on a forward basis. They make bets in between themselves about what the spot price will be at that time and decide to make a deal based on it . The cash price evolves. One guy will be right when the futures expires, the other wrong.
Their explanation is entirely correct. Suppose you're a farmer and you sold (that is, sold short) 1 contract of ZW just before the close today, which closed at $7.37. The rationale is that you want a hedge against falling prices in the future. Now further suppose you held the same contract until the expiration, which at that time ZW settled at $9.37. You obviously lost $2, but the good news is you can now sell your grain at the spot market for $9.37.
The basic difference between your example and exchange traded futures is that futures contracts are marked to market every day. If the next day someone else executed a contract for $3, the contract would be changed to $3 for delivery and the bread maker would send the farmer $1/bushel cash. They would do this every day until the contract was physically settled. Hope that helps.