Futures Trading Online

Futures trading online. Information on trading futures online.

In recent years, there has been a rise in popularity in futures trading online. But there is also a misconception in certain cycles about it. This misconception revolves around the economic role of futures trading. It arises from the belief that futures trading is a zero-sum game. People holding this belief may not realize the important economic role played by the market and futures trading online in enhancing efficiency of the capital market.

Economic Role of Futures Trading

What are the major economic functions of futures trading? They are:

• Price discovery
• Risk management and transfer
• Transactional efficiency

The significance of these economic functions depends upon a close relationship between cash and the futures market prices. As the price of a futures contract is linked to its underlying commodity, any improper pricing between the cash market and the futures contract would immediately attract arbitrage. Thus the presence of futures trading raises the efficiency of the cash market.

Now let us take a closer look at the economic functions.

Price Discovery: With many potential buyers and sellers trading in futures online, it is a very efficient way of establishing the equilibrium prices that reflect the current market expectations about what prices will be at specific points in the future.

Risk Management and Transfer: Most people and corporations dislike price risk, which exists because of uncertainty in the world. They want insurance against price risk. Online futures trading provides an efficient mechanism for allocating price risk from those who wish to avoid price risk to those who are interested in bearing the price risk for a potential return. In this way, they can reduce the price risks involved in doing business.

Options provide an additional benefit in transferring price risk. With the payment of a premium, the buyer of an option has the right, but not the obligation, to buy or to sell the underlying commodity at a specified price within a specified period of time.

Transactional Efficiency: Derivatives markets offer lower transaction costs of achieving specific risk and return positions than underlying cash markets. Also they provide, through the clearinghouse, an efficient mechanism for dealing with counter-party risks. Through margin deposits, the obligations of long and short position holders are assured.

If futures contracts were not available, a great portion of the hedging demand would be met by the over-the-counter market and credit risk would then become an issue.