Jim Cramers Real Money Sane Investing In An Insane World
STANDARDIZATION PROMOTES LIQUIDITY
Standardized delivery grades mean virtually anyone with sufficient capital can enter the market easily to hedge or speculate. Because the contracts are standardized, there's no confusion about what's on the block. A speculator who spots what is believed to be a trading opportunity can move into the market quickly, without first haggling to determine exactly what to buy or sell or when it will be delivered.
Similarly, hedgers know whether or not the product being traded can be used to offset their own risk in the spot market. Both speculators and hedgers can move in or out of the market with ease.
Increased participation by speculators and hedgers increases liquidity, and increased liquidity means lower transaction costs. Of course, for a contract to be a success, it's crucial that the specifications meet the requirements of end users or liquidity will suffer. A contract that doesn't provide delivery of grain when mills most require it offers few advantages. Similarly, delivery of a class of commodity or product that doesn't fit the commercial user's hedging needs will also have difficulty attracting liquidity.
Speculators must also be accommodated. While the terms of a grain contract should readily accommodate both farmers and millers, it must also be of a size that's attractive to speculators. A contract that is too big may force potential speculators to pony up a margin beyond their means. Similarly, a contract too small may attract investors unsuited for the volatility of a particular contract.
STANDARDIZATION PRODUCES MORE RELIABLE PRICE INFORMATION
Futures markets offer buyers and sellers more reliable price information than cash and forward markets. Forward markets often offer a number of delivery dates and locations. For most users, particularly nonprofessionals, it is often difficult to determine the market price. That's not the case with futures, which offer numerous products and designate a single delivery date for settlement.
What's more, futures quotations offer a combination of the price for a spot commodity plus the "carrying cost" (interest, insurance, etc.) of holding the commodity until delivery—a feature usually not found in spot market quotations.
