History: futures contracts and derivatives

More than 3000 years BC, the concept of money and banking developed in ancient Mesopotamia. Yet it wasn’t until the Romans gave money a name. The very first European banknotes were printed in Sweden in 1661, a few decades later the first derivatives markets developed in Europe. The best-known derivatives market was the Amsterdam tulip exchange, where tulip bulbs were traded using futures contracts.

Ancient Persians

On the Amsterdam tulip exchange, the best-known derivatives market, tulip bulbs were traded via futures contracts. However, the idea behind these futures contracts is much older: the Ancient Persians already hedged the risk of their harvest with derivatives.

Commodity trading

The trade in commodities, the basic goods and raw materials that humans need, is many thousands of years old. As long as civilization exists, commodities, the trade in raw materials, are essential. During the very beginning, goods were exchanged for goods. Later, goods were exchanged for gold, silver or other precious metals, and today we pay for our goods with money.

What are derivatives?

A “derivative” stands for a “derivative product.” A derivative gives the buyer the right to buy or sell a certain good or thing at a certain price.

Forward contracts

Futures contracts also have a long history. The largest exchange for gold, silver and other precious metals, the London Metal Exchange, dates back to the year 1571. The world’s most important futures exchange for agricultural products, the Chicago Board of Trade (CBOT) was founded in 1848. Commodities are mainly traded via the stock exchange with futures contracts.

Hedging risk

In the year 1865, the Chicago Board of Trade (CBOT) made a very important breakthrough: the first standardized futures contracts for wheat. By standardizing supply conditions, it was much easier for buyers and sellers of wheat to use the stock market to set an accurate price for wheat as a future crop, rather than relying on the constant price, the current spot price.

Price drops and shortages

The CBOT breakthrough allowed the:

  • Farmers (sellers) protect themselves against unforeseen price drops and
  • the buyers of wheat against unforeseen shortages.

Commodities

Even today, these standardized wheat futures are one of the most important exchange-traded commodities.

Investing in commodities

Investing in commodities is investing in raw materials. Raw materials such as: Gold, wheat, oil or cotton, for example. Raw materials that every person needs. These raw materials, the commodity, are traded with futures contracts.