The Theory of Futures Trading (Routledge Revivals) by Goss Barry;

Author:Goss, Barry;
Language: eng
Format: epub
ISBN: 1172896
Publisher: Taylor & Francis Group

The horizontal axis in Figure 3 is labelled ‘quantity of futures’. In fact it shows Sxi: aggregate net purchases by speculators. The model does not give the total number of futures contracts exchanged on the market, but this is readily seen to be ½S|xi|.

Neither does the model give the equilibrium holding of futures contracts for the individual, although this is easily found. Suppose theith speculator's expectations are such that(p — p′i) = C0 (see Figure 4). He expects the futures price to fall and will sell a quantity of futures x10.

Hedgers are then introduced to the model. Short hedgersreduce the risk of a fall in the spot price by selling futures. From this, Telser argues that futures trading increases the quantity of stocks a firm is willing to hold for a given supply price of storage. (As we have seen, Telser defined the supply price of storage asE(P) — P, where P is the spot price. Op. cit., p. 236.) The long hedger reduces the risk of a rise in the spot price by buying futures. This is taken to mean that futures trading diminishes the quantity of stocks a firm will wish to hold at each supply price of storage.

The net effect on firms’ total stockholding may go either way, and is called the ‘excess supply of futures’. It is equal to the supply of futures by short hedgers less the demand for futures by long hedgers (ibid., pp. 240–1).

Given the spot price and expectations of hedgers, the excess supply of futures is an increasing function of the futures price. This is because, as the futures price rises, first, short hedging becomes more profitable, so that short hedgers will hold more stocks and sell more futures; and second, the cost of long hedging increases so that long hedgers buy less futures. This is shown as the functionH in Figure 3. There will be some price 0C at which the supply by short hedgers equals the demand by long hedgers.

Telser's evidence (loc. cit., p. 240) indicates that hedgers are net short and speculators are net long, so that the intersection of theS andH curves is to the right of the point (0, 0). The excess supply of futures by hedgers (0Q) is equal to the excess demand for futures by speculators.

The equilibrium futures price is 0B, as before. Thus hedgers do not influence the level of the futures price, which depends only on the expectations of speculators and the strength of their reactions to their expectations as given by the seriesa1,a2, …,ai, …

The introduction of hedgers’ expectations means that ‘hedgers’ are speculators of a type. For if short hedgers expect the spot price to rise they will not hedge; similarly long hedgers will not hedge if they expect the spot price tofall. Indeed, if short hedgers are predominantly bullish and long hedgers are predominantly bearish, there may be few hedgers operating as such. TheH curve will shift to take into account the change in the net supply of futures by hedgers.

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