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What is a 'Futures Exchange'

A futures exchange, traditionally, is a term referring to a central marketplace where futures contracts and options on futures contracts trade. More recently, with the growth in electronic trading, it expanded to include the electronic marketplace. Most large futures exchanges also provide clearing and settlement functions.

Another name for futures and options is "derivatives" because their value depends, in part, on an underlying asset. As the name infers, futures prices are derived from the underlying asset.

BREAKING DOWN 'Futures Exchange'

Futures traded on a futures exchange allow the sellers of the underlying commodities the certainty on the price they will receive for their products at the market. At the same time, the exchange will enable consumers or buyers of those underlying commodities the certainty of the price they will pay, at a defined time in the future.

To maintain liquidity, contracts trading on an exchange have standardized sizes, expiration dates, and, for options, strike prices. This standardization contrasts to over-the-counter (OTC) contracts where buyers and sellers agree to the terms.

Before formal stock and futures exchanges, parties traded with one another directly. As such, activities were fragmented, and it was not always possible to offset a position with an equal and opposite position. This fragmentation is still a concern today in the over-the-counter (OTC) marketplace. In a futures exchange, the exchange itself is either the counterparty for both buyers and sellers, or provides access to specialized clearing firms. These firms ensure a liquid and safe medium for trading where all parties honor the trade no matter how the market itself changes.

Exchanges also provide pricing information, disseminated by information vendor firms. Information sharing allows for transparency in activities and fairness to all. Pricing information, including price, bids, and offers, is available to all interested institutions and individuals equally, no matter their size.

A Short History of Futures Exchanges in the U.S.

The largest futures exchange in the U.S., the Chicago Mercantile Exchange, was formed in the late 1890s when the only futures contracts offered were for agricultural products. The emergence of interest rate, or bond futures, and currency futures in major foreign exchange markets came in the 1970s. Today's futures exchanges are significantly larger, with hedging of financial instruments via futures. These futures hedging contracts comprise the majority of the futures market activity. Futures exchanges play an important role in the operation of the global financial system.

Financial exchanges saw many mergers, with the most significant being between the Chicago Mercantile Exchange and the Chicago Board of Trade (CBOT) in 2007. Rebranded as the CME Group, it then acquired NYMEX Holdings, Inc., the parent of the New York Mercantile Exchange (NYMEX) and Commodity Exchange, Inc (COMEX) in 2008. Growing again in 2012, it added the Kansas City Board of Trade, who is the dominant player in hard red winter wheat.

Another major player in the U.S. is the Intercontinental Exchange (ICE). Born as an electronic exchange in 2000, ICE acquired the International Petroleum Exchange (IPE) in 2001. In 2007, it obtained both the New York Board of Trade (NYBOT) and the Winnipeg Commodity Exchange (WCE). Finally, it expanded into equities with the acquisition of NYSE Euronext in 2013.

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