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gradus_ad

The weather affects all crops

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But isn’t the point that futures trading reduces volatility from things like weather?

“Absorbs” volatility might be more accurate.

I will resist the urge to inquire about the difference between reducing and absorbing.

I won't. What's the difference here between resisting and absorbing volatility?

Not a financial expert, but i think reduce implies it goes away, and absorb implies it’s still there but someone is taking it up.

Like reducing the amount of water on the floor would be turning off the tap. Absorbing the amount of water on the floor is when you mop it up.

That’s exactly what I meant. I was only replying to the question as posed.

Or to bring it back to the original context... Reducing volatility would be reducing the impact of bad weather on your harvest, absorbing volatility is finding someone to cover your losses. (presumably by giving up some profits on the good years. It's like a financial low pass filter)

Volatility is a natural consequence of weather, blight, etc., etc.

To reduce volatility you would need to actually stabilize the supply of onions.

What futures do is allow traders to shift risk from the future to the present. By pricing that risk, it's possible for people who depend on onions to pay a little more now in exchange for a guarantee about the future.

It's not magically going to make onions less volatile (although high risk prices can spur investment which might) but it can reduce disruptions caused by volatility.

The classic example of this is futures on jet fuel which allow airlines to weather random wars in the middle east, OPEC shenanigans, etc. Ticket prices are higher this way, but the existential threat of being forced to cancel a bunch of flights is gone.

Oh you’re talking supply volatility, where most of us are talking price volatility.

As long as demand remains inelastic, the two are the same.

If there is a supply shortage prices will rise; no amount of futures trading can create resources out of thin air.

The point is making money.

many users of derivatives willingly lose money on them because the purpose of these contracts is to transfer risk to those willing to hold it.

Money is the thing at risk.

Is insurance risking your money?

Yes of course. I’ve paid for car insurance for 30+ years and have never made a single claim. So far, for me, it’s a bad risk.

I’ll keep paying though.

People are willing to lose a small but predictable amount of money to avoid occasionally and unpredictably losing a massive amount of money. The former is a loss they can plan for and absorb. The latter might kill their business.

Traders are often happy to take the other side of that trade because they can trade against many counterparties, collect a small premium from each one, and try to ensure their counterparties won’t all fail in a correlated way.

Yes, it's not about onions.

The thing you’re missing:

Would you rather have net profits of 20, -10, 15, -5, -10, 25, -5 year over year, or profits of 4, 4, 4, 5, 4, 5, 5?

In what sense is “profits” not referring to money?

Did you reply to the wrong comment? I said nothing of the sort.

Your hung up on money, everyone is trying to explain that the exact same money is better when it is predictable versus erratic.

the exact same money

Yes, it is about the money.

You may have liabilities or income that exist outside of financial markets e.g. if I have 500t of wheat due to be harvested I might want to hedge enough to guarantee I can pay my staff - ive locked in the price of wheat, I might make less money as a result but my risk is lower.

Wheat futures trading rarely involves any actual wheat.

And rarely is done by farmers.

For speculators yes. But for a farmer and the consumer of the goods they would rather lock in a margin for their goods and run their business than risk guessing what the price will be at harvest time or consumption time. It’s called hedging.

How many farmers do you imagine are in this thread?

And consumers neither lock in margins nor run a business because consumers buy at retail…

Ok charitably, maybe you use “consumer” in a special sense of businesses that consume raw materials such as owners of onion ring factories. In those cases, future prices (as opposed futures prices) are typically negotiated directly into contracts with producers of those commodities…and how many of those are in this thread?

In the vast majority of cases, futures are traded speculatively and physical delivery of goods and chattles is an extreme exception.

Futures are a mechanism to transfer risk from one party to another, more or less.

To reduce net risk for both parties, at the expense of also reducing chances of windfalls.

To the farmer, futures mean no risk of having to sell when prices are low. To the buyer, futures mean no risk of having to buy when prices are high.

The farmer also gives up the chance of selling when prices are high, and the buyer gives up the chance of buying when prices are low.

The transfers go both ways, which is the magic.

You’re leaving out the speculators who usually end up assuming the risk of both the producer and buyer.

And the cost of transportation.

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