How exactly does a Futures Commissions Merchant (FCM) work and how does it generate revenue? I am having trouble understanding this concept?

According to Investopedia, this is what an FCM is:

A futures commission merchant is able to handle futures contract orders as well as extend credit to customers wishing to enter into such positions. These include many of the brokerages that investors in the futures markets deal with.

What does that mean?

Just as brokers can charge fees for a transaction, or lend investors money to purchase shares, an FCM does the same thing for futures. I.e., they can arrange futures transactions and collect a commission and they can lend money to investors who wish to purchase futures.

Futures typically pertain to commodities such as corn wheat or oil. Say you want to buy oil in march. The oil has not yet been produced nor do you know what it will cost in March. So you may want to hedge your purchase with a futures order. You contract to buy oil, in March at $80/barrel. maybe you buy 100 barrels. You pay a premium for this purchase maybe $5/barrel (I don’t have the exact figure). If in March the oil is selling for $90/barrel you buy it at $80 per your contract. Don’t forget you’ve already paid the $5 so your real price is $85. Still a bargain. If however, the price is less than $80 in March. you abandon you contract and buy it at market price, maybe $75/barrel. When you abandoned the contract however, you lost your $5/barrel investment.

Futures provide both investors and producers a way to insure thier cost/revenue. If you think the price of something will go up, you may want to buy futures. If you think it will go down, you may want to sell futures. Of course if you are guessing the same way as everybody else, futures get very expensive.

Just a thumbnail sketch of how they work.

@wundayatta has it right- FCMs are the futures equivalent of stock brokers; they are regulated by the National Futures Association (NFA) and the Commodity Futures Trading Commission (CFTC) instead of by FINRA (Financial Industry Regulatory Authority) and the SEC. They have an obligation to make sure futures are an appropriate investment for you, and handle the execution and clearance of your trade, and verify your margin maintenance.

@Jaxk – you can’t walk away from a futures contract that has gone down in value. If you don’t sell for a loss, you have to take delivery and pay the agreed price.

@zenvelo

You have me on that one. I will concede the point. You must pay the agreed price unless you sold the futures contract.