By: Sterling Terrell
Many say the existence of futures markets are good. Other say they are bad. I fall into the thought camp of the former. Futures markets work. We would be worse off without them. Here are 7 reasons why.
But what if the buyer of a particular futures (or options) contract is a speculator, while the seller of the same contract is a hedger? For example: A cotton producer sells cotton at $.70 and a speculator takes the opposite position. Harvest comes and cotton is $.80. The speculator has a $.10 profit, and the cotton producer sells his cotton for $.70 ($.80 cash cotton – $.10 hedging loss).
In this example, some would say the speculator had a $.10 gain and the cotton producer had a $.10 loss – end of story. While that is true, it is, however, not compete. The speculator took a calculated risk and came out on top. Which was what he wanted. The cotton grower hedged his crop at $.70 and offset all (or most) of his risk. Which was what he wanted. They both got what they wanted out of the transaction – and that makes both of them better off.
This is also true if the roles were reversed. What if the speculator was the one that sold at $.70, and the hedger (maybe a textile mill) was the one that bought. With the same move to $.80, the speculator would have a $.10 loss and the textile mill would have a $.10 gain. The speculator was again able to enter a trade with the proper risk/reward (although this time he lost money), and the hedger was again able to offset price risk by locking in $.70.
Once again, both parties to the trade got what they wanted – and that makes both of them better off.
In fact, it makes us all better off.