How Grain Futures Contracts Revolutionized Finance

At a Glance

  • Corn, Wheat and Oats Futures contracts launched 140 years ago
  • Contracts ushered in a global futures industry

 

This is the second in a series of stories on products critical to futures markets that have defined their progress over 150 years.

When the corn, wheat and oats futures contracts debuted in 1877, little did the 12 men who founded the Chicago Board of Trade realize they were creating a vehicle that would result in trillions of dollars traded globally every year.

Although the CBOT was founded in 1848, it still took nearly 30 years to develop standardized instruments for selling grain with delivery at some point in the future at a price determined today, says Fred Seamon, senior director, grains and oilseeds for CME Group.

At its inception, the CBOT centralized grain dealing, which represented the beginning of price discovery and price transparency, Seamon says, but it was still just a seasonal cash market because farmers and merchants met only around harvest. Chicago grew as a major city because of its location on Lake Michigan and as a major rail hub, but even with key shipping and rail lines, merchants had trouble handling the volume of grain flowing into the city at harvest.

That changed when storage capacity was built in Chicago. Soon storage owners and farmers realized they could reap higher returns if they could wait to sell grain later in the crop year, Seamon says. Thus, the first forward contracts started, and those eventually evolved into standardized contracts for corn, wheat and oats.

“It was those contracts in 1877 that became the first futures contracts. It was the building of storage in Chicago that really facilitated the drive to the first forward contracts and eventually to futures contracts,” Seamon says, adding the corn, wheat and oats contracts eventually ushered in the global futures industry.

And 140 years later, they remain relevant as the global grain price benchmarks, with the corn futures contract one of the world’s most-traded commodities markets. To understand how much volume has grown, in 1921, the oldest historical data available, annual corn trading volume was 1.17 million contracts. In 2016, annual volume was a record 85.6 million.

Corn historic volume

Wheat also set record volume in 2016, at 31 million contracts traded, substantially more than the 2.5 million traded in 1921. Although oats volume is not what it was in 1921, at 530,738 contracts versus 225,230 in 2016, the U.S. no longer consumes as many oats since the invention of the automobile replaced horses for transportation.

Wheat historic volume

For decades, the grain futures primarily reflected the domestic markets, but between 2000 and 2006 a few events caused the grain markets to become bigger and more globally focused, Seamon says.

First was changing the corn contract to river delivery, which reflects pricing to export terminals at the Gulf of Mexico, he says, which was necessary since nearly all of the grain storage in Chicago had closed. Wheat already had several river and rail locations dedicated to supplying Gulf terminals.

“It really was at that point that the markets started to evolve from being predominately domestic in scope into international markets where the prices being discovered were actually global prices. Global participation started to increase as well,” says Seamon.

Another big change came in 2006 with the introduction of daytime electronic trading, exposing the markets to an even greater number of both domestic and global participants. At this time the commodities boom was underway, increasing to the number new participants to go along with the traditional grain merchants, farmers and other traditional non-commercial participants.

Grain Inspection 1940s CBOT

Corn, wheat and oats inspected at the Chicago Board of Trade inspection desks circa 1940.

Electronic trade has made a big difference, says Karl Setzer, analyst at MaxYield Cooperative in West Bend, Iowa. “I can sit at my desk in the rural Midwest and get instant fills,” he says. “Before I could put an order in at 9:30 a.m. and it might not have gotten filled until 1 p.m. on a busy day.”

Screen-based trading also helped the contracts stay dominant. While regional grain markets sprung up in different parts of the world, the liquidity at the CBOT drew the majority of global market participation, allowing the CBOT markets to keep their bellwether statuses, Seamon says.

Glenn Hollander, partner in Hollander and Feuerhaken, and whose family has worked at the CBOT since the early 1900s, reflected on the markets’ evolution.  He says as volume has grown, more people who are not connected directly to agriculture trade the markets, making the grain markets an asset class.

Setzer agreed the grain markets reflect interest of the new participants. “The grains may reflect what the Dow or Nasdaq is doing, but they may also reflect what’s happening in the Ukraine or South America,” he says.

Grain Trading Floor 1900

The Chicago Board of Trade grain trading floor, 1900.

Options on futures gives market participants more ways to hedge, Seamon and Hollander say. There are the standard monthly options, but even shorter-dated options, like weekly options, which lets users tailor hedges around events like USDA crop reports, Seamon said.

Hollander says with the addition of more non-commercial market participants, prices do not necessarily trade on purely agricultural fundamental reasons, like grain supply and demand, but may reflect additional economic influences. Still, they remain relevant for farmers and end-users globally as a means of price discovery and transparency.

“The farmer in Indiana or the farmer in South America can turn around and see the futures market is going up or down, so he has an indication the market has changed. He doesn’t have to rely on XYZ Grain Co if their bids haven’t changed…. The same thing goes for the export buyer or the processing plant,” he says.

Craig Floss, chief executive officer of the Iowa Corn Growers Association, which celebrates its 50th anniversary this year as the oldest and largest corn growers’ association, says the contracts are critical to the global food supply chain. These contracts bring stability to both producers and end-users, especially for countries that aren’t self-sufficient in food production.

“Obviously, a country is not going to want to trade with an unreliable partner,” he says. “This kind of a legal contract gives both sides some confidence that the transaction will go through. And no country wants to rely on someone else if they’re going to fail to bring forward what they need as it relates to feeding people.”

 

Debbie Carlson has focused on commodities for much of her writing career. She spent more than a decade at Dow Jones covering the Chicago-based futures exchanges. As a Dow Jones editor, she worked closely with The Wall Street Journal and Barron's in planning commodities coverage.

Additional Recent Articles in Commodities