Futures Contracts Trading – The Origins

By | May 19, 2017
History of futures contracts trading

Futures contracts trading exists for two main reasons: one is to secure a financial flow, while the other is to make a gambit for great profit.

There are many different versions that one can dig into to really understand where futures trading came from. Among the different stories, two major narratives are commonly used.

Futures contracts trading can be dated back to the times of Aristotle and then the periods in Japan.

Futures contracts trading – The Aristotle story

The first reference to a futures contract was made by Aristotle, that great philosopher!

He related the story of Thales (or Thales of Miletus), who we could only describe as an ambitious businessman. This first story is an example of the second purpose for futures contracts.

Thales had pretty good foresight and could make good predictions regarding the olive harvests. Feeling that the upcoming olive harvest would be huge, he decided to negotiate with the owners of olive presses in the locale.

Were olives the first commodity to be traded via futures contracts?

Olive presses are used to press olives for their oil, which is a staple in many Aegean and Mediterranean cultures. Still, when there are no olives, these presses basically stay still and aren’t worth a whole lot.

Thales knew this and thus offered to deposit money with the press owners. Because the olive season was still in the future, Thales was able to negotiate a lower price. The owners took him up, because they were not very sure about just how large the olive harvest would be. Thales got a contract for exclusive use of the presses when the olive harvest rolled around.

When the olives came to fruition – literally – Thales then rented out the presses at rates that he controlled. The crop was a good one, and all the presses were wanted for use, all at the same time. This meant a payoff for Thales, and all in all he made a tidy profit, in addition showing just how foresight and risk-taking can improve profit.

Futures contracts trading – The origins in Japan

The following is a paraphrasing of historical events in Japan that are also related to futures trading. In fact, it is an example of an exchanges market, as well as a forerunner of modern banking systems in Japan.

In the Edo Period of Japan’s history, rice was the main medium of exchange. Rice was the very foundation of the Japanese economy, and it was even used to pay the samurai for their services in guarding nobility.

In the 1730s, the price of rice plummeted as a result of poor-quality harvests and trade issues (most likely abusive merchants taking advantage of poor farmers). The samurai went into panics, since this meant that they made that much less money, after their rice was converted into coin.

Japanese proverb on rice futures

Japanese proverb on rice futures

At the same time, conspirators and high-profile merchants worked to keep rice hidden away from the public, artificially keeping prices low.

People were going hungry and riots increased both in frequency and size. The shogunate was forced to step in on numerous occasions, setting price floors and ceilings, while keeping a watch on devious merchants.

The Dojima Rice Exchange was officially organized by the shogunate in 1773. This rice exchange demonstrated the economic effects of setting limits on prices and the use of contracts of financial value – basically staple prices, interest rates and paper money.

The merchants in the Dojima Rice Exchange would hold rice in their warehouses, exchanging it for money, and they also held accounts for many samurai and nobles, in essence becoming a sort of bank.

Farmers could expect to make a certain amount of money for the rice they brought. The government also had its own warehouses, where the stored rice could have been set aside for emergencies.

In the end, the Dojima Rice Exchange was a regulating body that kept prices and the economy quite stable, keeping the flow of finances relatively steady for everyone.

The Dojima Rice Exchange was dissolved completely in 1939, as the Government Rice Agency took over its responsibilities.

Who are the people who trade futures?

Today philosophers and samurai are limited in number, or rather more so than they used to be. So who use futures in our modern world?

Well, if you keep the two main reasons for futures in mind – securing cash flow and financial gambits – you can basically consider all businesses as potential users. Usually though, it is the big businesses that go into these contracts.

For example, your company needs funds to start or continue the development of a new product. You approach venture capitalist with deep pockets, and propose a futures contract. In this case, the capitalist want physical items that he can then resell through his personal network, so the futures contract is of an ideal physical type.

The capitalist gives you money now, you complete research and development, produce batches to cover your obligations and more, and then hold up your end of the futures contract on time. In this case, the contract is completed regardless of market forces.

Another example: Your company needs investors. Because your performance has not exactly been stellar, investors are not flocking to you, so you decide to go out and get them.

You approach some of them, offering a futures contract – they purchase stocks now at the current market price, and you promise to improve the stocks’ price level with various business strategies.

At the final settlement time, you hold up your end by delivering the promised increased stock prices, the path to which could not have been taken without the money of your contracted investors.

On the other hand, it could also be buyers that propose the contract, so do not go about thinking that it is always sellers that instigate contact for a futures contract.

Interested to learn more about futures contracts trading?

Share, tweet or like below and unlock a PDF guide that details the origins of futures trading since the ages. A case study from Harvard Business School.

Dojima Rice Futures Case Study

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