Why is it that every time someone mentions futures trading someone comes along to drop the farmer's crops example, do y'all really have no other examples?
What percentage of futures trading is on farmers crops?
What about the crops they destroy because they would be less profitable? Does the protection against monetary risk outweigh starving people to death?
How well will it work if we create unsustainable land that the farmers can no longer grow crops on?
I don't have a percentage for you but agriculture-related futures make up a non-negligible amount of overall trading. It's not just some artificial example. Agricultural futures were also the first futures, and much of today's trading infrastructure was built around agricultural futures. So that's probably part of why it is such a common example.
They are far from the only example. Airlines use futures to hedge against fluctuations in fuel prices. Manufacturers use futures to hedge against fluctuations in the price of input materials. International businesses use FX swaps to hedge against currency fluctuations. Borrowers use interest rate swaps to hedge against interest rate rises. Investment funds (including pension funds and sovereign wealth funds) use options to hedge against drastic movements in asset prices.
I don't really understand your other questions. The use of derivatives in agriculture does not, on balance, result in fewer crops being produced. On the contrary, by allowing farmers to protect themselves against various risk, derivatives markets allow farmers to safely invest more money in production, and reduces the risk of farmers going bankrupt (bankrupt farmers don't produce many crops). Food would almost certainly be more scarce and more expensive if farmers did not have access to the financial markets.
The reality is that in any futures market 99% of the trading is done by speculators and algorithms. The farmer in your example doesn't normally have the time to keep up with everything going on in the market and will probably end up being ripped off by fees and expensive derivative products marketed to them by unscrupulous brokers.
But wouldn't they want the futures market to have perfect information? So that the futures could be priced exactly right, which would mean the lowest possible price that counterbalances a down market perfectly?
I assume the farmers aren't trying to make money from the futures, they're just trying to not lose money. Their profits come from actually growing food. The futures are just there in case something bad happens. Right?
Because that’s what futures are for? Consumers and producers of commodities want to lock in prices to lower the risk of price fluctuations in the future.
The relationship between futures traders and farmers is pretty much identical to that between any kind of insurance company and its customers - it's a risk arbitrage transaction where the client (farmers in this case) are sacrificing profit in expectation for a flatter outcome curve which in a properly priced market yields higher utility in expectation, since utility as a function of profit is concave for an individual farmer and much closer to linear for a well-capitalized market maker.
The one goal of future contracts is for producers and consumers to be able to make deals before that production and consumption happens. Those are the primary dealers there, and I don't really remember where I got statistics, but AFAIK, they are about 10% of the volume.
On top of those primary deals, a lot of people pile up making bets on secondary deals. Those are the people going for "hey, a lot more farms are growing rice this year, I bet its price will fall". They are very welcome because they not only stabilize the prices on those markets, but they also provide short-term money to make the deals flow more homogeneously. Without them, making deals on those markets would be a profession by itself (as it was).
Now, there exist people making bets on the results of the bets of the secondary market. That is a different market. At some point it's clear that this becomes toxic, but nobody seems to agree on what point exactly.
> What about the crops they destroy because they would be less profitable?
You mean farmers getting bankrupt? You seem to be misunderstand, because the main reason farmers love the futures market is because it lowers their risks.
> How well will it work if we create unsustainable land that the farmers can no longer grow crops on?
Well, surely if you go and kill everybody, there will be nobody losing money on those markets.
"...farmers benefit from a price that accurately reflects the supply and demand of their product."
But does society benefit when it's cheaper to let the crops rot than take delivery?
"This is an example of futures working well because that oil otherwise would've been dumped or burned since the price was negative"
The whole reason they weren't dumping oil and tankers where making bank was because you can't legally dump it. That is why rates were negative - you had to put it somewhere and many of the contract holders where speculators with nowhere to put it.
"Without futures farmers would have to buy price insurance through some sort of middleman insurance company, which is almost certainly more expensive than the market."
They already have crop insurance, which includes price issues...
Ok this might have been a bad example. I'm aware that Futures historically play a role of an insurance for food producers. Are those then by volume the major part of so called food speculation?
> A Lincolnshire farmer — and yes, I like the non-abstract solidly of the example — is not the optimal holder of the ‘risk’ that the Australian and Kansas wheat harvests are super-bountiful. Markets allow that risk to be transferred to a non-farmer better able to hold the risk.
Are you familiar with the arguments of (more popularly) Aaron Brown and (transitively) Jeffrey Williams?
Essentially, the idea that a farmer would be an active participant in a futures market is quaint, but the vast majority of activity is speculation. This is not a contradiction of your point, but an elaboration of a counter-intuitive part of it.
One might look at a futures market and see that well over 98 % of the activity is buying and selling by people who never have any reason to care about wheat other than for the possibility of its price going up or down. But this large-scale speculation is precisely the thing that makes it possible for a farmer to hedge (by providing liquidity and a motive for the counterpart of the hedge) or, as Williams' points out, perhaps more commonly "take out loans in commodities" for their convenience yield.
Essentially, the Lincolnshire farmer can lock in a price with a plain forward contract. However, that does take a double coincidence of demands (or whatever the phrase is) and the standardised nature of futures contracts help avoid that problem.
But! The most common use of futures contracts (aside from speculation) is not (or at least was not, when Williams wrote his book) hedging, but effectively borrowing and lending in commodities.
> Selling crop futures protect you against the price of your crops falling.
Price contracts are a thing. You can do this in new england with fuel oil for heating. It is fairly common.
But futures pay today for a product at some later date. It's a loan as well.
And as a producer it's not just a hedge on price. What happens if your expect to yield 140 bushels of corn an acre, and only get 130? Your crop came in, so no insurance, how do you make up the missing bushels? You're buying those futures back or delivering the contract even at 10x the price.
That isn't an outcome one expects from a hedge or insurance.
There is a reason that there are specialists in marketing and delivery of products with futures markets that help them plan.
> Futures have substantial utility for anyone who needs to hedge the underlying commodities.
1. CME has futures for much more than just commodities. They have futures for S&P 500, interest rates, and cryptocurrencies (lol)
2. The daily volume for corn futures is 350,000 contracts[1]. Each contract corresponds to 5,000 bushels, which means 1.75 billion bushels worth of corn are being traded daily. On the other hand the US only produces 14.18 billion bushels yearly, and the world only produces 44.64 billion bushels[2]. Given the large disparity between trade volumes and actual production, I doubt most of the trading activity are from people "who needs to hedge the underlying commodities".
futures contracts work somewhat well for farmers. There's a level of certainty provided and they are reducing their risk so that a low price at the end of the season doesn't ruin them (however they also don't profit from a higher price). As a farmer i would likely prefer to sell a certain percentage of my goods with a futures contract so that i can have less risk of financial ruin.
So why isn't there a futures market for selling these meats?
The farmer/producer would like certainty of sale, at a certainty of price. This is exactly what a futures option gives them - they can offload the risk of price fluctuations (and demand reduction/changes) in the future, and someone else can speculate on this (and make more profit, or loss).
It seems stupid for a farmer/producer to take on this risk, rather than sell these futures.
Thank you for the detailed explanation, that makes sense. I don't doubt that you want someone with financial expertise to handle futures trades. Since your example shows you're trading one risk for another.
I guess a better way to put it is: In the right package, selling futures can be a part of an effective insurance strategy for farmers.
But futures aren't like that; futures are supposed to be one of the lower layers of the financial "abstraction stack", not the top layer.
Grandma doesn't buy futures; grandma invests in a mutual fund that buys futures. But Harold the wheat farmer does buy wheat futures directly, because his whole business is delivering wheat down a manufacturing pipeline, and the wheat future delivers wheat just like his own fields will, so either can be used as an input to said manufacturing pipeline. That's the original point of [commodities] futures, after all—to let Harold hedge his wheat-growing risk. The fact that they can be traded like any other instrument to make money without ever coming into possession of any commodities at all, is just a weird side-effect.
I'd venture farmers make half or more more of their money on futures markets. Argi-business is a global market and optimal prices for your commodities don't necessarily conform to your local conditions/crops/etc.
I can't speak for all farmers, but my family owns a farm and the futures market is huge in it generating money.
You can use the futures markets to hedge against bad crop yields, lock in profits for accounting and cash flow purposes, inform what crops you are going to grow. It's immensely valuable.
What percentage of futures trading is on farmers crops?
What about the crops they destroy because they would be less profitable? Does the protection against monetary risk outweigh starving people to death?
How well will it work if we create unsustainable land that the farmers can no longer grow crops on?
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