There’s a case to made that the human animal has a natural inclination to gamble. Because, where the buying and selling of goods, services and financial instruments is concerned, it is not enough to just pay for what you get.
No, these days folks are willing to pay for what they might get. And without ever taking possession of that which they are paying for.
This qualifies as gambling pure and simple, because the buying and selling of “futures” without any underlying intrinsic product value is no different than laying your money onto a Las Vegas table.
Defining a Futures Contract
A futures contract is just what it says: a contract to buy a quantified block of something that has intrinsic value – such as 100 shares or stock, or a rail car full of lumber or other commodity goods – for a specified price, and at a specified data sometime in the future. That price may or may not be the same as the going rate at the time of the trade, which means the value of the contract depends solely on the perception of the market – a prediction – of the price level at that future date.
Why would anyone do this?
Again, pure and simple: to make money. Because if the trending within a given market is up, people are willing to bet on that trend. Which means, they’ll pay a premium for a quantity of goods now that they won’t – theoretically – take possession of until a later date.
They do this based on the belief that the price they pay now, even though it is perhaps higher than today’s price (and it will be if the trending for that product is going up), will be a bargain when the time comes to actually take possession.
Sooner or later all futures contracts expire, which means someone is left holding the bag (sometimes literally, if the product is, say, corn). Because at that time, the person holding a futures contract that is, in even, coming due (they call it expiring in the trading game) is obligated to actually pay the price agreed to in the contract and take possession of the actual physical goods.
What are those goods?
There is a huge futures market in commodities, everything from pork bellies to corn to boxcars full of lumber. Virtually anything and everything that comprises the raw material of modern life trades as a futures contract, which means that just about everything we eat, touch and build in our daily lives has at one time been the stuff of such a transaction.
Stocks as Futures Contracts
Stocks are traded as futures, as well. They’re called options, and they involve two basic types:
o Call options, which obligate the buyer (at least for the time they hold the contract) to buy 100 shares (per option) at the stated option price, regardless of what the market price might be. People buy call options in the belief that the price of the underlying stock will go up, meaning the price of the option will go up with it. Most options traders unload the contract (hopefully at a profit) long before the expiration date, as they never had any intention in acquiring the stock itself. It’s all just speculation, rather than good old fashioned investing in a good company.
o Put options, which obligate the holder/holder to sell 100 shares of a stock at a given price on the expiration date. If they own the stock they just sell it, and if they don’t own it they must simultaneously buy it in the market at the going price in order to cover the sale per the option contract.
Premium Pricing
With both forms, and with both stock options and commodity options, the market places a premium on the price based on the strength of their belief in the momentum of the given stock or commodity. If a stock or the price of a particular commodity is going up rapidly, the option price would be more than the actually price at the time of the futures contract trade.
Some firms who manufacture the underlying commodities are involved in trading futures contracts as a means of hedging their revenue in the event of a price decline. The same goes for investors (particularly large funds) who acquire blocks of stock, who can use options to limit risk and/or generate immediate revenue.
Even in it’s most basic form it’s complex stuff, and there are combinations of long and short positions that make it even more complicated. This is no place for the timid or the uninitiated, but for the enlightened investor futures contracts greatly expand the scope of possibilities.
Just like in Las Vegas. Because every trade, every bet, has a winner and a loser.