There are many myths and misunderstandings about futures prices
- What do they mean ?
- Where they come from ?
- And aren't they just gambling really ?
In the section below we get behind the myths and explain just what makes up futures prices, and what futures prices mean:
If you asked 3 executives from the steel industry, "what will be the FOB Antwerp price of base grade HRC from first class West European mills in 6 months time ?", you might get answers of US$ 300, US$ 330, and US$ 285. The average of their opinions would be US$ 305.
Now, you might ask them for prices based on 100 tons, and prices based on 1000 tons and 10,000 tons. The 3 executives are likely to adjust their estimates accordingly. For example, 100 ton lots might be priced slightly higher than 10,000 tons lots.
Now, if you asked them for prices for 7 months hence, the pricing of the preceding period - the 6-month prices just discussed - will have an influence on the executive's opinion on the 7-month price. The executives will be stating their 7 month opinion on the basis of
their own opinion of the 6-month and 7-month price
the opinions the 2 other executives expressed for the 6-moonth price
the average 6-moonth price of US$ 305
Essentially, what a Futures Exchange does is provide a forum for the expressions of such opinions about 'future' prices of the product underlying the futures contract, over a number of delivery periods in the future. Because every contract has exactly the same volume of exactly the same underlying, to be delivered to exactly the same place, its easy not to get caught up in technicalities of 'superior vs inferior' qualities, or 'expensive and inexpensive' shipment ports. All those elements are standardized in futures contracts. Everyone can purely focus on price.
In a futures market, rather than have an average of just three opinions, you've got many hundreds, even hundreds of thousands, of opinions of price expressed every day for every delivery period in the future.
Furthermore, those opinions of given credence because they are expressed through the buying and selling of futures contracts. These futures contracts actually commit the seller or buyer of such contracts to make or take delivery of the underlying. So we're not talking random, uneducated or even educated guesses of what prices may be. We're talking commitments to buy and sell very significant volumes of steel.
Set within the framework of appropriate regulatory and legal environments, futures markets are highly efficient mechanisms to centralize credible opinions about price to transparently discover future prices at which committed and knowledgeable market participants are prepared to buy and sell steel.
If you asked 3 executives from the steel industry, "what will be the FOB Antwerp price of base grade HRC from first class West European mills in 6 months time ?", you might get answers of US$ 300, US$ 330, and US$ 285. The average of their opinions would be US$ 305.
Now, you might ask them for prices based on 100 tons, and prices based on 1000 tons and 10,000 tons. The 3 executives are likely to adjust their estimates accordingly. For example, 100 ton lots might be priced slightly higher than 10,000 tons lots.
Now, if you asked them for prices for 7 months hence, the pricing of the preceding period - the 6-month prices just discussed - will have an influence on the executive's opinion on the 7-month price. The executives will be stating their 7 month opinion on the basis of
their own opinion of the 6-month and 7-month price
the opinions the 2 other executives expressed for the 6-moonth price
the average 6-moonth price of US$ 305
Essentially, what a Futures Exchange does is provide a forum for the expressions of such opinions about 'future' prices of the product underlying the futures contract, over a number of delivery periods in the future. Because every contract has exactly the same volume of exactly the same underlying, to be delivered to exactly the same place, its easy not to get caught up in technicalities of 'superior vs inferior' qualities, or 'expensive and inexpensive' shipment ports. All those elements are standardized in futures contracts. Everyone can purely focus on price.
In a futures market, rather than have an average of just three opinions, you've got many hundreds, even hundreds of thousands, of opinions of price expressed every day for every delivery period in the future.
Furthermore, those opinions of given credence because they are expressed through the buying and selling of futures contracts. These futures contracts actually commit the seller or buyer of such contracts to make or take delivery of the underlying. So we're not talking random, uneducated or even educated guesses of what prices may be. We're talking commitments to buy and sell very significant volumes of steel.
Set within the framework of appropriate regulatory and legal environments, futures markets are highly efficient mechanisms to centralize credible opinions about price to transparently discover future prices at which committed and knowledgeable market participants are prepared to buy and sell steel.
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