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How Futures and Options Markets Work

 August 08, 2007 11:57 PM


A futures market, like any market, is a place where buyers and sellers meet in order to transact. For every buyer, there is a seller and for every seller, there is a buyer. Matching these two together so that a trade can be consummated requires the participation of a host of individuals and organizations, each having specific roles, which in the aggregate make the futures market the efficient mechanism that it is today. Throughout this section, reference is made solely to the futures market only for convenience and simplicity of presentation. The market for options on futures is structured in very much the same manner.commodity futures broker, futures trader, commodities futures trading, financial and commodity futures markets, paper trading, full service broker assisted accounts.
The Futures and Options Exchange
The central player of a futures market is a futures exchange. A futures exchange is a meeting place where futures contracts are bought and sold. Trading occurs against a background of regulatory surveliance and guidelines from the exchange itself and from the Commodity Futures Trading Commission (CFTC). Each exchange has its own list of products that it trades, and each product is traded in a designated futures trading pit. A trading pit is an area of floor, usually round with concentric steps leading down into the center. The trading pits are each divided into a number of sections designated for trading in particular contract months. No trading may occur outside a contract's assigned pit, nor is trading permitted at any time other than during those hours which have been designated by the exchange. (Some exchanges also use automated trading facilities or computer networks which serve as trading pits.)

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In addition to providing the market place for trading futures and regulating trading within its pits, futures exchanges also design and specify their futures contracts. Futures contracts are very specific in terms of the quality and quantity of goods underlying the contract. You may have wondered who determines these specifications. The answer is the futures exchange. Working with participants in the industry such as traders, fund managers and natural hedgers, a futures exchange designs a contract to meet the greatest need. If the exchange succeeds, it will have designed a futures product that many players can use or trade, and volume in the futures will grow. Contract specifications can sometimes be changed by the exchange, and is usually done to keep the contract viable. For this reason, it is a good idea to periodically check the specifications of the contracts that you trade or want to trade.commodity futures broker, futures trader, commodities futures trading, financial and commodity futures markets, paper trading, full service broker assisted accounts.
The Futures Broker
Buying or selling a futures contract or an option on a futures contract can only be done in one place: the trading pit on the floor of a futures exchange. To stand in a trading pit, you need to buy an exchange membership, pay annual dues, and register with various regulatory agencies. Naturally, few people would trade futures if it required that they stand in the trading pit. To solve this problem, in steps the futures broker. Your broker acts as a communication link between the trading pit and you, taking orders from you, the customer, and executing them in the futures pit.
commodity futures broker, futures trader, commodities futures trading, financial and commodity futures markets, paper trading, full service broker assisted accounts.

This is the traditional path that a futures order takes as it passes through the system:

1.


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Why Trade Futures and Options? The Trading Plan
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