Throughout wall street futures have had the reputation of being a game that is only played by high-risk speculators. But the truth is they play an important roll in stabilizing prices. There are two distinct types of players in this market.
The hedgers are primarily interested in the commodities. They consist of producers, like farmers, mining companies, foresters, and oil drillers. or they can be users, like bankers, paper mills, jewelers, and oil producers. The main difference between these two types of hedgers is; the producers sell the futures contracts, and the users buy them. The primary concern of the hedger, is to protect themselves against price increases that will undercut their profits.
Then there are the speculators, they trade futures strictly to make money. If you trade in the futures market, but never use the commodity itself, then you are speculator. Most speculators will buy and sell futures contracts, depending on which way the market happens to be going at the time with any particular commodity. Sometimes they will sell their futures contracts for more money than they paid for them, and use the profit that they make to off-set the higher price they will have to pay in the cash market. Either way, there aren’t any surprises in added commodity costs because the cash price and the futures price cancel each other out.
Speculators try to make money in the futures market by betting on price move. For instance a speculator might load up on futures pertaining to a particular cash crop in the hopes that if an act of “God” occurs and the crop is damaged that the prices of the crop will soar along with the futures contracts that are based on that particular crop.
If the speculators happen to be right, then the futures contracts for that commodity will be worth more than they paid for them. This in-able them to sell their contracts for a profit. However if they are wrong and the crop that they are betting on turns out to be a bumper crop that year, the bottom will fall out and the speculators will be squeezed dry.
Futures and options are very different from, stocks, bonds, and mutual funds because they fall into what is known as zero sum markets. This simply means that every time someone playing in this market makes a dollar, someone else loses a dollar in this market.