To understand how futures work, it helps to understand their history. We’ll discuss the formation of the Chicago exchange, the market’s participants, and what the futures market looks like today.

The first exchange

The first U.S. futures exchange appeared in 19th century Chicago. Before the establishment of the futures exchanges, Midwest farmers took their crops to Chicago to sell them. Farmers harvested at the same time of year. The huge supply of grain often made prices fall. This meant a smaller payday. Some farmers couldn’t find a buyer. They were left with a wagon full of unsellable goods. These goods were often dumped in the streets or in Lake Michigan.

The creation of futures contracts solved this problem. Futures allowed farmers to find a buyer ahead of time and lock in a price for their crop. Farmers were capable of transferring the price risk because the price was predetermined. They passed on the risk to the user or speculator. This person was willing to hold the contract and bet on the direction of the underlying’s price movements. So, even if prices fell, farmers would already have a buyer and a price for their goods. Nevertheless, this also meant that if prices rose, farmers would lose out on the gains to the speculator. That was the risk farmers were willing to take for the certainty of a buyer.

Participants

Two market participants rose out of the creation of the futures market: hedgers and speculators. In the overall futures market, hedgers include producers and users. They can find a buyer or seller. Hedgers set a price. Speculators are institutions or individuals looking to profit from changes in futures contract prices.

Contracts are standardized for delivery, quality, and quantity of the underlying asset. Thus, hedgers feel confident they were getting the product they wanted. Producers and users are not buying and selling at the same time. So, it helps to have speculators as possible buyers or sellers. Users and producers can transfer some of that price risk. Speculators are a constant presence and willing participants in the market. Hence, they offer liquidity.

The futures markets have grown since the 19th century. Futures products span across six different types of assets: equity indexes, energy, metals, interest rates, agriculture, and currencies. The table below shows the top-traded contracts and symbols in these groups. 

Today’s markets

Another big change is that the most widely traded futures products are no longer grains. Equity index futures are now one of the most popularly traded products. For that reason, we’ll use these indexes as the example in our sample investing plan later in the course. We’ll explain more about how they work in the coming lessons.

Hedgers and speculators are still the two primary futures traders. Today, hedgers are large commercial operations—like producers, farmers, wholesalers, and retailers—that are trying to secure a price. For example, airline companies have enormous fuel costs. Rising fuel prices can hurt the bottom line. So, they often look to hedge using futures contracts to control those costs.

Speculators are institutions or individuals looking to profit from changes in futures contract prices. Note that when we talk about traders “hedging” a stock portfolio, we are actually referring to a type of speculation. Traders hope that changes in the futures price will offset losses in their stock portfolio by entering a futures position. We’ll talk more about this on the next page.