One of the most exciting and little understood markets available to the investor is the Futures Option Market, or Commodity Trading. It is similar to the Stock Options Trading market in many ways, but there are also some major differences. Some of the terminology used in Futures Trading also has a different meaning than the same term when applied to Stock Option Trading, and caution must be used to avoid confusion.
In the United States, all of the trading of future contracts are recorded and monitored by the Commodity Futures Trading Commission (CFTC). This agency was created by Congress in 1974 and replaced the earlier Commodity Exchange Authority. The CFTC acts as a watchdog over the entire market, and has considerable power in enforcing its rules and standards.
The Future trading market is often called the Commodity Market, or commodity exchange. This is because the underlying asset is a commodity rather than a share of stock. The commodity can be almost anything from a barrel of olive oil to the value of an index. The most important difference between a Future option and a stock option is that the contract in a Future option gives you the right and the obligation to purchase or sell the underlying asset at a certain price on a specified date. It is obligation that is the key difference, as the stock option is a true option, and no obligation exists.
The trading of commodities has a long history. Some claim the market can trace its origins back to the Roman era. It was certainly active in Japan several centuries ago where the trade was in rice and silk. The market began in the United States in Chicago in the early part of the nineteenth century. Chicago grew and became a centre for transportation and for the trading of the agricultural products of the growing Midwest. The massive amounts of produce that flowed into Chicago coupled with the primitive methods of transportation and communication created virtual chaos. The supply and demand of various commodities fluctuated wildly, and as they did prices rose and fell so quickly that everyone involved were constantly at risk. The market developed to provide some measure of protection from these risks.
The basic concept behind the market was the idea of “forward” contracts. The forward contract was basically a promise to buy now, but pay and deliver later. It brought order to the chaotic market place because suppliers were given some security that their products would be purchased at an acceptable price.
From this beginning, the concept of forward trading developed in the modern futures market. It has been regulated and brought under control, but it remains a volatile and expanding entity. The definition of commodity continues to expand. No longer is it restricted to grain and cattle, but now includes just about every disposable item, as well as non-tangibles like interest rates, and financial instruments. Economist debate over where the definition of commodity will reach its end. Is it an infinite concept? Are such things as human life and free time considered commodities?
One thing is certain. The Future Options Market is incredibly complex, and very little that happens in the world does not impact the prices of the future. Weather conditions impact agricultural output. Political events on the other side of the World impact oil prices. The global economy intertwines more and more each day as transportation and communication continue to shrink the globe.
All of this may appear extremely daunting to the beginning investor, but with a little bit of work with the terminology and the procedures of the market, a profitable and exciting investment option awaits.
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