Futures Trading: Seinfeld Style - Part 2

Scott Irwin (a prominent Agricultural Economics Professor at The University of Illinois) cowrote a book with Doug Peterson called, Back to the Futures - Crashing Dirt bikes, Chasing cows, and Unraveling the Mystery of Commodity Futures Markets.  As the experts, I lean heavily on their work throughout these Substack posts to isolate some key explanations from the book.  

In the second chapter of the book, Irwin & Peterson craft a brilliant yet simplified explanation of a complex market using a well-known cast from the hit-sitcom Seinfeld to describe how the futures market for grain commodities function.  

Part 1 of this post describes the CBOT origin story to broadly describe the market utility and Part 2 outlines the basic application of the futures market using Seinfeld characters to set the scene.  

“[W]hen forward contracts started in 1851, another problem soon arose. What if you wanted to get out of your side of the contract? 

To understand why you might want to do that, let’s go back to our grain elevator operator, George, and the company, Vandelay Industries. Let’s say Vandelay agrees to buy corn from George at $1 per bushel for delivery in March. But in a few weeks, what if Vandelay Industries thinks it can by corn for even less — 75 cents per bushel?  

Vandelay could do one of two things.

One: It could break the contract with George and probably get Sued. Or, two: Vandelay Industries could find someone to take their side of the contract.  

If another company, the Kramer Group, thinks prices will rise, not fall, they might be willing to take Vandelay’s side of the contract. Buy low, sell high—basic trading rules.  

Vandelay honchos think prices will go down, so they bail out, while the Kramer Group takes the contract because they believe prices will increase.  Only time will tell who is right. The two parties do not deal with each other directly, operating through the exchange’s clearinghouse, which acts as a go-between. 

The genius of the futures market is that it allows everyone a way to manage price risk, also known as price exposure. There’s always an escape hatch. If you want to get out of your contract, find somebody to take your side of the agreement.”   

~ Chapter 2: Daredevils

If you enjoyed this excerpt, I highly encourage you to pick up a copy of the book!