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An exchange or futures market is a central financial exchange where people can trade standardized futures contracts; that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future. These types of contracts fall into the category of derivatives. The opposite of the futures market is the spots market, where trades will occur immediately (2 business days) after a transaction agreement has been made, rather than at a predetermined time in the future. Instruments are priced according to the movement of the underlying asset (stock, physical commodity, index, etc.). The aforementioned category is named “derivatives” because the value of these instruments are derived from another asset class.
According to The New Palgrave Dictionary of Economics (Newbery 2008), futures markets “provide partial income risk insurance to producers whose output is risky, but very effective insurance to commodity stockholders at remarkably low cost. Speculators absorb some of the risk but hedging appears to drive most commodity markets. The equilibrium price can be either below or above the (rationally) expected future price (backwardation or contango)…Rollover hedges can extend insurance from short-horizon contracts over longer periods.”
