Futures Contract Pricing
How are futures priced?
The pricing of a futures contract involves a myriad of factors - but it all starts with the underlying value of the commodity.
So what determines the pricing of the underlying commodity? The good ole' law of supply and demand of course! An abundant commodity will sell cheap, a scarce commodity will sell expensive. A commodity with little demand will be cheap, a commodity with high demand will be expensive. Most commodities move in predictable cycles - seasonal for farm goods like avocados, economic cycles for industrial goods like oil. However, cycles are frequently disrupted. In January 2007, freezing temperatures caused significant damage to the $1billion+ in California citrus farms. As a result, fewer oranges than expected were delivered, causing a supply shortfall. The slim supplies in turn caused a rise in orange prices. The rise in the price of oranges resulted in an increase of the orange futures contract.
Underlying prices do NOT tell the whole picture. Other factors such as anticipated weather, estimated orders, and fears of price spikes motivate futures traders.
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