Futures
A futures contract is a derivative financial instrument/contract used by exchanges as a standardized agreement for buying and selling an underlying asset. When the contract is made, the buyer and seller agree on the price and delivery date. The quality, quantity, packaging, and other parameters are predefined in the exchange contract specifications.
What is a Futures?
A futures is a derivative instrument, which is a standardized legal agreement to buy or sell an asset at a price agreed upon at a specific futures date. Futures are typically traded on regulated exchanges and are used for speculative trading, hedging, and portfolio diversification.
How Futures Work
Futures contracts are commitments between two parties: a buyer (who agrees to buy the asset) and a seller (who agrees to sell the asset) at expiration. Unlike spot markets, where assets are exchanged immediately, futures markets involve settlement over time.
Key Components of Futures Contracts
- Underlying Asset: Commodities (steel, oil, gold, wheat), financial instruments (stocks, indices, bonds, fiat currencies), or cryptocurrencies.
- Contract Size: The amount of the underlying asset per contract.
- Expiration Date: The exact date on which the contract will be settled.
- Margin Requirement: Margin is posted as collateral by traders to enter a futures trade.
- Leverage: Futures are typically traded with high leverage, increasing potential profits and potential losses.
Types of Futures
- Commodity Futures - contracts based on physical commodities such as crude oil, natural gas, or agricultural products.
- Financial Futures - futures on financial assets such as stock indices, interest rates, corporate securities, or currencies.
- Cryptocurrency futures are futures on virtual assets such as Bitcoin, Ethereum, or other cryptocurrencies.
Why trade futures?
Futures and derivatives in general (see derivatives) greatly increase the variety of financial transactions available to all participants in both exchange and over-the-counter trading:
- Hedging: Investors hedge (insure) themselves against price risk using futures. For example, farmers estimate their futures harvest in advance to avoid losses due to expected market uncertainty.
- Speculation: Exchange traders profit from price fluctuations without holding the underlying asset.
- Liquidity: Futures markets are highly liquid, making it easy to enter and exit positions.
- Price discovery: Futures trading on a global scale allows the economy to determine fair market prices for assets.
Risks of Using Futures
- Leverage Risks: High leverage can increase losses beyond the initial margin deposit, resulting in liquidation of the position and loss of investment funds.
- Market Volatility: Random price movements can trigger margin calls and forced liquidation of positions.
- Expiration and Rollover: A trader must manage contract expiration to prevent delivery or closing of positions.
Futures: Conclusion
Futures trading is a powerful financial instrument widely used in traditional and cryptocurrency markets. While they offer great opportunities for profit, they also carry great risks. Investors and speculators should understand the functions of futures contracts and implement sound risk management techniques before trading futures.