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        History of Futures Trading

        History of Futures Trading - Introduction

        Futures trading is one of the most powerful and important financial activities taking place in the financial markets worldwide. Futures are traded in almost every capital and commodities market in the world and has proven to be an extremely important price discovery and risk management tool especially in the commodities market. Futures have since evolved to become much more than just the hedging tool it was designed to be but also important arbitrage and speculation tool.

        So, when did this fantastic financial instrument start? How did it develop and evolve to become the futures market we see today?

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        History of Futures Trading - a Timeline

        The major stages of development in the history futures trading are recorded in the timeline below:

        History of Futures Trading Timeline

        Brief History of Futures Trading

        Futures contracts evolved from what were known as "Forward Contracts". Forward contracts serve the same function as futures contracts except for the fact that forward contracts are privately entered into by producer and buyer of a commodity without an official exchange nor standardized terms. First accounts of forward contracts facilitating the trading of physical commodities can be traced back all the way to biblical times and have been in use through the middle ages. Even though such forward committments have been in existence for thousands of years, the development of the modern futures market that we know today actually started in the US in the early nineteenth century from "to-arrive" contracts used by grain merchants with the formation of the Chicago Board of Trade (CBOT) in 1848. As time goes by, futures trading became more and more regulated and standardized, creating the open and public futures market we know today with standardized and guaranteed futures contracts. Futures trading expanded beyond commodities after 1970, extending to currency futures, interest rate futures and eventually stocks and indexes of all types.

        Ancient History of Futures Trading

        Futures trading can be traced back to the ancient babylonian times where it probably took the form of forward contracts promising the delivery of a specific commodity at a specific future time for a specific price and entered into privately between a seller and a buyer. Such transactions are recorded in tablets made with clay which survived the river of time. These agreements between sellers and buyers formed the basis for the forward contracts that are still used today, from which the futures market evolved. There were no exchanges nor clearinghouses to guarantee the performance of these contracts or to facilitate the trading of these contracts. Such forward contracts continue to be used throughout ancient times across the world in its primitive form until a group of grain merchants in Chicago decided to form an organization known as the Chicago Board of Trade (CBOT).

        Rise of Modern Futures Trading - Beginning of CBOT 1848

        The beginning of modern futures trading started with the formation of the Chicago Board of Trade (CBOT) in 1848. In the 1840s, Chicago became an important commodities transportation and distribution center in the USA due to its geographical advantage. Farmers from the Midwest would bring their harvest to Chicago for sale every year but because grain is seasonal, the seasonal over and under supply would cause sharp increase in price during the non harvest times and a sharp decrease in price during harvest due to oversupply. In fact, prices fluctuate so wildly that grain sellers are forced to dump their grain into the Chicago River as the expenses involved in selling the grain elsewhere would result in a loss due to the low selling price. This is the exact same situation for fresh pork in China before the pork futures started in 2010.

        This situation caused huge inefficiencies in the marketplace and caused losses to sellers to buyers alike. With the formation of the CBOT, the first modern form of a futures contract known as the "to-arrive" contract was invented. This is different from the "hedge-to-arrive" contracts that are traded in the futures market today. "to-arrive" contracts are a form of forward contract which led on to the development of the more complex futures contract.

        "To-arrive" contracts led to steadier grain prices and higher market efficiency and trading in "to-arrive" contracts grew explosively. In fact, traders soon found it easier to trade in the "to-arrive" contracts themselves which led to an explosive growth in trading volume and a need for standardization of these contracts. Standardization of these contracts in 1865 truly took "to-arrive" contracts from being a form of forward contract to a true futures contract with standardized terms and conditions that can be freely traded and offsetted in a futures exchange. This led to the development of futures exchanges where these early "futures contracts" were traded. In fact, most of the "futures contracts" (it was still known as "to-arrive" contracts then) were offsetted before expiration with no actual delivery of the underlying asset, suggesting the speculative kind of trading that we see today. This period also saw the growth and increase in the number of futures exchanges such as the Chicago Mercantile Exchange (CME).

        Beginning of Modern Futures Trading - The First Clearinghouse 1884

        The basic structure of modern futures markets is completed with the setting up of the CBOT's clearinghouse, which is the first formal clearinghouse in the world, in 1884. The functions of a clearinghouse was completed and made mandatory only in 1925 after decades of development.

        Futures Trading Extended Beyond Commodities 1971

        Futures broke out of its confines for the facilitation of commodities trading in 1972 with the introduction of forex futures. With the removal of world currencies from the gold standard in 1971, the new fiat money, which is really a freely traded commodity on its own, allowed futures to be traded on a financial instrument for the first time, creating financial futures. This allowed regulators to see how futures trading can be useful in all manners of financial instruments, leading on to the invention of cash settled futures contracts.

        Futures Trading Come Under Full Government Regulation 1974

        Since the beginning of "to-arrive" contracts trading in the US along the Chicago River, this "futures" market has been organized by the merchants involved in the CBOT who make all the rules privately without regulation from the government. Due to the widespread speculation in grain futures, trading in futures also came under heavy legislation pressure all over the US during this period. Market manipulation through cornering, risky speculation and organized, institutional, futures gamblers posed great challenge to the stability of commodities prices, leading to calls to outlaw futures trading all the way up to 1895. By 1936, the Commodity Exchange Act was passed which gave the government rights to investigate and prosecute illegal futures trading activities and price manipulation. However, at this point in time, the government still had no say in how the CBOT, its clearinghouse and exchanges conducted their business. It was not until the passing of the Commodity Futures Trading Commission (CFTC) in 1974 that made the government the regulator of the whole futures trading market that commodity futures trading became fully regulated.

        Cash Settled Futures Begun 1975

        Regulators experimented with futures trading on the first non-physical commodity after the launch of foreign currency futures, which is interest rates. Interest rate, as the cost of money, are subject to market forces and is an important "commodity" to speculate in or hedge against for anyone involved in the dealing of money. However, due to the fact that it is not a physical commodity that can be exchanged physically at the end of the life of a futures contract, a new concept known as "Cash Settlement" was conceived and the Eurodollar Futures, which is futures contracts on the interest rate paid for US dollars deposited overseas, became the first ever cash settled futures contract. The feasibility and convenience of cash settled futures opened the door to expanding futures trading into more non-physical commodities as well as physical commodities. One of the most important of cash settled futures is the introduction of stock index futures in 1982 on the S&P500 index.

        Ban On Single Stock Futures Lifted 2000

        The 18 year ban on single stock futures trading was finally lifted in 2000, completing the full range of futures trading products in the US market.

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