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History of Futures Trading

The “history” of “futures” trading sounds like an oxymoron. However, futures trading history is not only a real thing, it’s a very important subject.

Today, we’re teaching you everything you need to know about the history of futures exchanges, futures markets, and futures trading – from ancient Mesopotamia to the modern era.

Ancient Mesopotamia Futures Trading: The Place It All Began

Futures trading can be traced all the way back to 1750 BCE in Mesopotamia, located in present-day Iraq.

You may have heard of the sixth Babylonian king, Hammurabi. He’s best known for creating the famous Code of Hammurabi, which was one of the world’s first written legal codes.

Part of that Code stipulated that goods and assets had to be delivered for an agreed-upon price at a future date. In order for goods and assets to be sold at that price, there needed to be a written (and witnessed) contract.

This part of the code quickly led to a type of active derivatives market. Ancient Mesopotamians would gather at temples to exchange forward and futures contracts.

Futures Trading in Ancient Greece

Mesopotamia doesn’t get all the credit for the history of futures trading. Ancient Greeks also got involved.

We know about ancient Greek futures trading because it’s mentioned in Aristotle’s Politics, where Aristotle tells the story of Thales, a poor philosopher from Miletus who created what’s described as a “financial device, which involves a principle of universal application.”

Aristotle claims that Thales used his skill in forecasting to become a wealthy man. As an example, Thales predicted that Greece’s olive harvest would be particularly strong the following autumn. To make money from that prediction, Thales made agreements with local olive-press owners to deposit his money with them, guaranteeing that he could use their olive presses when the harvest was ready.

Here’s how Thales made money: Thales secured low prices on his contracts because the harvest was in the future, and nobody knew whether next year’s olive harvest was going to be large or small.

Thales was taking a risk. Meanwhile, olive press owners wanted to hedge against the possibility of a poor harvest. They were trading the possibility of a future windfall for the security of a fixed price today.

Of course, the next year, harvest-time arrived in Greece. There was a huge increase in the demand for olive presses. Demand outstripped supply, and Thales sold his future-use olive press contracts at a rate of his choosing, making a large quantity of money in the process (source).

There’s some debate about whether or not Thales’ businesses venture truly constitutes futures trading. Some people have compared it more to an option contract (after all, Thales was not obliged to use the olive presses if there was a poor harvest).

Nevertheless, between the ancient Greeks and ancient Mesopotamians, there’s sufficient evidence of futures trading existing before the modern era.

Modern Futures Trading in Japan

Japan is credited with creating the first futures exchanges in the modern era. Japan’s futures markets can be traced back to 1700s at the Dojima Rice Exchange in Osaka.

That rice exchange was the center of Osaka’s rice broker industry. The exchange was first established in 1697, which was when the Japanese economy was undergoing an unusual surge in prosperity. In 1697, the rice exchange received an official license from the Shogunate (the national government at the time).

By 1710, merchants were trading futures contracts based on the perceived future value of rice. 1710 is the official date at which the modern futures exchanges market is thought to have begun.

Why was a rice exchange so important in Japan? Well, Japan’s feudal lords and samurai during this time period weren’t paid in cash: they were paid in rice.

That’s why the rice broker industry became so important: samurai and feudal lords needed to exchange rice for cash, and places like the Dojima Rice Exchange gave them a market in which to do it.

In fact, the brokers on the Dojima Rice Exchange are credited with introducing and spreading paper money across Japan. They’re also credited with creating modern futures exchanges.

The Rice Crisis of the 1730s

The Dojima Rice Exchange became increasingly important starting in the 1730s, when the price of rice plummeted across Japan. At first, this seemed like a good thing for buyers, as it meant rice (a food staple) was cheaply available. However, since the entire economy of Japan depended on rice, it wreaked havoc on the economy, which still largely used race as a medium of exchange.

Samurai – the people who were paid entirely in rice – began to panic. Their income had just plummeted, relative to real value.

That’s when the rice brokers’ community sprung into action. Speculators began playing games with the system to influence the value of rice. Speculators would hold onto vast warehouses of rice, for example. Starving Japanese populations began to riot against these speculators. Eventually, the Shogunate stepped in and secured a minimum price for rice, bringing at least some security to the economy.

Japan’s dependence on rice obviously led to an extreme example of the power of futures exchanges and futures markets. However, Japan officially gets credit for the creation of futures markets.

19th Century London was the Next Major Region to Employ Futures Trading

Stock market trading in general is linked back to coffee houses in 16th century London. English futures trading has similar origins, tracing its roots back to the opening of London’s Royal Exchange in 1571.

The London Metal Exchange – known officially as the London Metal Market and Exchange Company – was founded in 1877. This exchange was responsible for trading copper, lead, and zinc, firmly establishing metals and ores as key commodities on futures markets. Between the 1970s and 2010, metals like aluminum, nickel, tin, steel, cobalt, and molybdenum would be added.

Today, the total value of futures trading on the London Metal Exchange is approximately $12 trillion. In fact, trading on the LME exceeds world metal production by a factor of 40.

Six different types of contracts are available against 13 underlying LME metals. Clients can trade on the LME by working through an LME member. You can learn more about the LME at www.lme.com

Futures Trading in the United States

Chicago’s proximity to the farmlands and cattle pastures of the Midwest made it a logical place for futures trading to emerge. The Chicago Mercantile Exchange was created in the 19th century. Today, it’s the largest future exchange in the world.

The farmlands and cattle around Illinois are only part of the reason why Chicago was so successful in creating a future exchange. Chicago was also the hub of transportation, distribution, and trading of agricultural production.

When agricultural produce prices were high, Chicago was booming. When prices were low, Chicago and its surroundings were in bad shape. The Chicago Mercantile Exchange was a logical way for agricultural companies to hedge their bets in an uncertain industry. They were able to insulate themselves from the inherent market risks of running an agricultural business.

It all started in 1848 when Chicago decided to create a way to regulate forward contracts. At the time, forward contracts were standard among agricultural producers: agricultural producers would sell forward contracts. However, if the price of that commodity varied dramatically by the time the produce was delivered, either the buyer or seller would drop out, making the forward contracts virtually useless.

Chicago needed a formal system that enforced the price of futures. In 1848, the Chicago Board of Trade (CBOT) was formed. The CBOT specialized in the trading of forward contracts. Its first forward contract was a contract for corn. By 1865, the CBOT had created a standardized system for futures contracts.

Later, in 1874, the CBOT created the Chicago Produce exchange, which was renamed to the Chicago Butter and Egg Board in 1898. During the First World War, the exchange suspended activity. Then, in 1919, it was reorganized into the Chicago Mercantile Exchange, or CME.

The Chicago Mercantile Exchange (CME) solidified its place as the world’s largest futures exchange in 2008, when CME acquired NYMEX Holdings, Inc., the parent company of the New York Mercantile Exchange and Commodity Exchange.

The Chicago Mercantile Exchange creates the International Monetary Market

The CME’s impact on futures exchanges was far from over. In 1972, the CME created a division within itself called the International Monetary Market, or IMM. This market offered contracts in foreign currencies, including the British pound, Canadian dollar, German Mark, Japanese yen, Mexican peso, and Swiss franc.

The creation of the IMM is credited to Leo Melamed, an American attorney and finance executive. He’s often labeled as the pioneer of financial futures. Born in Bialystok, Poland in 1932, Melamed today serves as an advisor on futures markets to governments around the world.

The IMM did more than just allow currency futures trading: it also allowed for interest rate futures trading – including 90 day US Treasury bills and 3-month Eurodollar time deposits.

The IMM continues to exist as one of three CME divisions to this day. The other two are the Index and Option Market (IOM) and Growth and Emerging Markets (GEM). All CME products fall into one of these three divisions.

The Minneapolis Futures Market

When it comes to the history of futures trading in America, the story is dominated by the Chicago Mercantile Exchange.

However, there’s an interesting story to be told in Minneapolis, Minnesota. The city created its own regional market in 1881, and allowed futures exchanges throughout that market starting in 1883.

Trading continues to this day on Minneapolis’s regional market. It’s called the Minneapolis Grain Exchange, and it’s the only exchange that allows for hard red spring wheat futures and options.

The Expansion of Futures Trading in the 1970s

We mentioned above that the Chicago Mercantile Exchange started offering futures trading in foreign currencies starting in 1972 with the founding of the International Monetary Market.

This was just one of several major expansions in futures trading that occurred in the 1970s.

In New York, the New York Mercantile Exchange began to offer trading in various financial futures, including US Treasury bonds. Eventually, the NYMEX would offer futures trading in stock market indexes. A division called the Commodities Exchange also allowed for futures trading in gold, silver, and copper. Platinum and palladium were added later after the US dollar removed itself from the gold standard.

During this time period, futures contracts became available on the Dow Jones and S&P 500 stock indexes.

Today, futures trading exchanges can be found all over the world, but America remains the home of the most active futures trading markets. That’s because two of the most-heavily traded markets are the US bond market and the wheat market, both of which have an active worldwide presence.

The Financial Futures Explodes with Growth After the End of the Bretton Woods Exchange Rate Regime

We just mentioned that futures trading expanded rapidly in the 1970s. This expansion can be traced directly back to the breakdown of the Bretton Woods exchange rate system.

We could write an entire history article about the Bretton Woods exchange rate regime, but essentially, the breakdown of this system in the 1970s meant that the US dollar was no longer pegged to the value of gold, which opened the economy to more fluctuations.

When the US dollar stopped being pegged to gold, it fixed the relative values of industrial economies’ exchange rates to the US dollar. It led to a system of flexible exchange rates along with side effects like high inflation.

The introduction of flexible exchange rates and high inflation presented an opportunity for futures markets. More uncertainty in the global economy meant that more people would be seeking to hedge their bets in the futures markets.

This is when financial futures markets started to grow. Prior to this point, most futures markets (particularly in America) involved agricultural commodities. Today, agricultural commodities are still frequently traded on futures markets, although financial futures and options are by far the most dominant part of the market.

Modern Futures Trading

Modern futures trading is (understandably) quite different from the commodity-based exchanges of the 19th and early 20th centuries.

First, open outcry trading has declined in popularity. The vast majority of trades are performed electronically. More significantly, approximately 99% of all futures contracts are settled prior to maturity.

Today, traders can easily speculate on the price of virtually any commodity going up or down in the future. You can speculate on the price of corn, lumber, gold, or even potatoes, for example. You can speculate on the price of currencies all over the world.

At the same time, the futures market today is more liquid than it’s ever been before. Huge numbers of contracts (trillions and trillions of dollars every year) are traded daily. This ensures that market orders – whether you’re buying or selling – can be completed very quickly. That’s why it’s unusual for prices to suddenly jump unexpectedly – especially on nearer contracts.

Conclusion

The history of futures trading is as old as civilization itself. It can be traced back to ancient Babylon and Greece, when merchants exchanged forward contracts. These merchants all sought the same thing: they wanted to cash in at a fixed price today to avoid the risk of tomorrow. Futures traders, on the other hand, sought to buy at a low fixed price today on the assumption that prices would rise in the future.

Over time, we’ve seen the logical progression of futures trading, from American agricultural futures markets in the Midwest, all the way to the modern currency trading and financial futures exchanges that started in the 1970s and has come to dominate the futures markets to this day.

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