Do you know that it’s illegal to trade Onion futures? I certainly didn’t, and they do make a fascinating study on the how futures trading might or might not affect commodity prices.

Onion prices have been fluctuating more wildly than even other food commodities. Many think this is because of the ban on the trading of Onion futures. The conventional wisdom today is that speculators in the future markets drive price volatility. A great deal of blame has been laid at the feet of oil speculators. However, a properly functioning futures market should do exactly the opposite. When properly used futures create price certainty that helps smooth volatility.

For example without oil futures, oil production companies are less likely to make infrastructure investments for future supply as they cannot guarantee the price at which they can sell the oil at a later date. By trading futures, an oil company can lock profits that can be put towards infrastructure. If oil prices end up moving lower, the oil company is in no worse financial shape. Without futures, the oil company might drilling oil that uneconomic to recover. If oil companies must bear all that risk then are likely to be more conservative in it’s infrastructure investments.

Of course many the proponent of additional regulation in futures market want only to restrict speculators who have no natural position in the commodity. An oil producer, and airlines have natural positions in the oil market. The oil company needs to sell future production while airlines need to purchase jet fuel for flights in the future. A financial participant has no such interest, but this is not to say they do not have a proper role in the market. Speculators should on the most part drive volatility down. Without speculators, the liquidity in the market would be less and lead to wider price variations.