| Feb 9 2012, 10:30:06 GMT | Sydney: | 20:30 | Tokyo: | 19:30 | Barcelona: | 11:30 | London: | 10:30 | New York: | 05:30 | San Francisco: | 02:30 |
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A futures contract is introduced to address a specific industry’s need to hedge against disruptive variation in its supply.
1. Designed so futures prices and cash prices converge over time
2. Stable and predictable basis between cash and futures differences
3. Contract specifications fit industry standards
Much research is done before a futures contract is introduced or an existing one is modified to ensure the contract will coincide with current industry practices and norms. Industry experts and contract users are consulted, along with academic experts and other experts like government graders.
The terms and conditions of a futures contract are set to encompass the mainstream of the commodity in the marketplace so futures prices and major cash market values converge when the futures expire. Convergence enables sellers of futures to easily find product to deliver when futures prices are high relative to cash prices, and also enables buyers of futures to easily find an outlet for the product they might receive on delivery, making them comfortable to “stand for delivery” when futures prices are low relative to cash prices. All of that makes futures prices reflective of the main cash markets. A stable and predictable basis (cash – futures difference) exists for most hedgers results, so they find it conducive to use the contract.
Few deliveries are actually needed to achieve convergence – just the possibility of delivery is usually enough.
Cash market practices and norms change over time, so the futures contract terms need to keep pace. The process of altering futures contract specifications is lengthy, easily lasting a year or more, because of separate studies and the required approvals by the Exchange and later by the CFTC. Once a change that has an effect on prices has obtained final approval by the CFTC, it can only be implemented in contract months yet to be listed to avoid changing the rules in the middle of the game.
A wait of another year or so is normal, for a total of about two years from the beginning of the process until a change is operational.
