Futures Markets

Abstract

In the mid-1800s, Chicago was the transportation and distribution center for agriculture products. Farmers in the Midwest transported and sold their products to wholesalers and merchants in Chicago, who often would store and later transport the products by either rail or the Great Lakes to population centers in the East. Because of the seasonal nature of grains and other agriculture products and the lack of adequate storage facilities, farmers and merchants began to use forward contracts as a way of avoiding storage costs and pricing risk. These contracts were agreements in which two parties agreed to exchange commodities for cash at a future date, but with the terms and the price agreed upon in the present. An Ohio farmer in June might agree to sell his expected wheat harvest to a Chicago grain dealer in September at an agreed-upon price. This forward contract enabled both the farmer and the dealer to lock in the September wheat price in June. In 1848, the Chicago Board of Trade (CBT) was formed by a group of Chicago merchants to facilitate the trading of grain. This organization subsequently introduced the first standardized forward contract, called a “to-arrive” contract. Later, it established rules for trading the contracts and developed a system in which traders ensured their performance by depositing good-faith money to a third party. These actions made it possible for speculators as well as farmers and dealers who were hedging their positions to trade their forward contracts. By definition, futures are marketable forward contracts. Thus, the CBT evolved from a board offering forward contracts to the United States’ first organized exchange listing futures contracts—a futures exchange.