Quote from z32000:
Can someone please explain how the futures market actually benefits say for example the corn industry.
For example, say I was a farmer and I was able to round up about $10,000 worth of corn....
if I sold or purchased corn futures.... how do I actually benefit from this? Can it save me from overgrowing corn in the fall? Right now, all I can think of futures is just a gambling pit. I'm not so clear as to how does it benefit the actual industry.
The futures contract allows the farmer to "hedge" the actual physical commodity that he is growing in the ground and has yet to harvest.
If he has commitments to sell his $10,000 worth of corn harvest to an end-user, but the yield from his crop is poor due to inclimate weather or insects, etc. - - - he is gonna wind-up being "short" of the amount of corn he has promised to his customer. With the futures contract, he has the ability to "hedge" the forward production of his crop and make good on his contract for 'X' amount of corn to be delivered to his customer. In similar fashion, the end-user can also "hedge" against the expected price rise due to poor yields by purchasing futures contracts so as to keep their cost down.
In an opposite scenario, should the farmers harvest be unusually strong ( along with other farmers in the region ) yielding above average yields, he might then be concerned about corn prices falling due to oversupply of the commodity. He can use the future's markets to sell his forward production and "lock-in" a specific price before his crop is ever harvested; hence taking price risk and uncertainty out of his business.
Commodities contracts allow the physical producer the ability to quantify risk, against a whole set of economic variables . . . from weather to war.
It is by no means a "gambling" pit for the producer. It is a very specific tool used to take the UNCERTAINTY out of their business model. Just ask anyone from Cargil to International Foods, to Nabisco, to Folgers Coffee, to Valero Refining to Exxon-Mobil to Weyerhauser, to DuPont or PPG or any of the Airlines that need to "hedge" against aviation fuel prices.
This is Basic Econ 101A.
