The idea is to buffer changes in price. Started with crops originally iirc. Say I know I need 1 ton of seed for planting. It normally costs $5,000/ton. I am concerned that the rat epidemic might cause a seed shortage. It does. 1 ton of seed next year is worth $20,000. Because I purchased the future of 1 ton of seed for $5,000, I am not affected by this.
Made up numbers obviously, as I know someone is just waiting to “well akshually” me.
Question: how does that rat case actually work out followed through slightly more? If enough players bought at $5k/ton and the seed shortage increases prices due to scarcity, what happens when there's only enough seeds to meet 3/4ths of demand?
1) If the contract is physically settled vs financially settled.
2) The existence of a clearinghouse - which is a middleman in charge of making sure both parties deliver on their contractual obligations. Virtually all futures contracts go through a clearinghouse.
Lets assume that it is physically settled with no clearinghouse - what happens is the same as any other contract where the other party does not deliver on the terms of the contract (also known as FTD - failure to deliver).
In theory price v demand. Prices would increase until demand was reduced to the point that there was enough seed for everyone willing to pay the price.
It also depends whether you’re trading future that settle for cash (you buy for 5k and they give you 20k cold hard cash) or whether they’re actually going to send a semi truck to your farm, in which case they should have been holding enough collateral for such an incident.
Realistically, I believe most futures are cash settled and you’d probably be better off pocketing the extra 15k and spending 5k on planting a different crop this year.
Made up numbers obviously, as I know someone is just waiting to “well akshually” me.