What are futures contracts?-WWNEED.COM
If you are wondering about the meaning of futures contracts and how to profit from them, here is now an explanation of everything related to what futures are and how they work.
A forward contract is a legal agreement to buy or sell a specific commodity asset or security at a predetermined price at a specified time in the future. Care is often taken to standardize futures contracts in terms of quality and quantity in order to facilitate the process of trading them on the futures exchange. In this contract, the buyer of the futures contract has the legal obligation to purchase and take delivery of the asset when the futures contract expires. The seller of the futures contract, on the other hand, is obligated to provide and deliver the asset on the date the contract expires.
Futures contracts belong to the category of financial derivatives, which commit the buyer to buy and the seller to sell some asset at a predetermined future price and date. A futures contract allows an investor to speculate in the direction of a security, commodity or financial instrument, whether long or short term, using leverage. These contracts are often used to hedge the price movement of an underlying asset to help prevent losses from unfavorable price changes in the future.
Understand the meaning of futures contracts
To understand the meaning of futures contracts well, always remember that futures contracts are derivative financial contracts that oblige the parties, often the buyer and seller, to deal with an asset at a predetermined future date and price. Here, the buyer must purchase the specified asset and the seller must compulsively sell it at a specified price in the future, regardless of the current market price on the expiry date of the contract. Assets that will be bought and sold. Futures contracts are often used for the purpose of hedging or trading speculation.
When someone mentions “futures,” they are usually referring to a specific type of futures contract, such as oil, gold, bonds, or a market index futures contract. These contracts are also one of the most direct ways to invest in oil.
Futures contracts are similar types of agreements that determine a certain future price at the present time, and these contracts have customizable terms that are reached between the counterparties to the contract.
This type of contract is adopted by two classes of market participants, hedgers and speculators. The producers or buyers of assets with futures contracts hedge or guarantee the price at which the commodity is bought or sold. Portfolio managers and traders may also bet on the price movements of the underlying asset using futures contracts. Futures contracts also provide sellers of commodities such as oil with an effective way to lock in the selling price and hedge against market volatility.
Some major manufacturers may also need oil to meet their production and industrial needs. Since they will sometimes like to plan ahead with the need to get oil every month, they may also use futures contracts. This way they will be able to know in advance the price they will pay for the oil (the futures price) and they will be sure that they will get the oil once the contract expires. Futures contracts are available on many different types of assets. There are futures contracts on stock indices,commodities and currencies.
Explanation of futures contracts
Imagine that an oil producing company plans to produce 1 million barrels of oil over the next year. This sleeve will be ready for delivery within 12 months. Assume the current price is $75 per barrel. A producer can produce oil to sell at current market prices one year from today, but since oil prices are constantly fluctuating, the market price at that time may be very different from the current price. If an oil producer thinks that oil will rise in one year, he may choose not to fix the price now. But if the company thinks $75 is a good price and can…decreases in the future, they can secure a guaranteed selling price by obtaining a forward contract. A specific mathematical model is used for futures pricing, which takes into account the current spot rate, risk-free rate of return, duration to maturity, storage costs, earnings and dividend yields as well as appropriate yields. Suppose the producing company acquires a one-year oil futures contract at $78 per barrel. By entering into this contract, the producer is obligated in one year to deliver 1 million barrels of oil and is guaranteed to receive 78 million dollars. The price of $78 per barrel is received regardless of the spot market price movements at the time. for example For example, one oil contract on the Chicago Mercantile Exchange (CME) is for 1,000 barrels of oil. So, if someone wanted to fix a price (buy or sell) on 100,000 barrels of oil, they would need to buy or sell 100 contracts. To fix the price of 1 million barrels of oil, they would need to buy or sell 1,000 future contracts. Futures markets are regulated by the Commodity Futures Trading Commission, whose main purpose is to prevent abusive trading practices, prevent fraud and regulate brokerage firms engaged in futures trading.
There are a variety of types of these contracts, which are determined depending on the type of underlying asset. The assets that are traded in a forward contract include the following:
Goods
They are hard assets such as wheat, gold or oil. Among these commodities, oil futures contracts may be the most important because they determine the price of oil and oil prices, in turn, are the main determinant of the price of gas. Higher oil prices will lead to higher pumping prices as well. Commodity prices are often volatile, and trading commodity futures contracts is a risky venture for traders.
Stocks and bonds
Traders can trade futures contracts for financial instruments when they feel an impending shift in the economic trend. If they think prices will go down, for example, they might buy a bond futures contract (this is because bond prices go up when interest rates go down). If a trader believes that the stock will rise, he can buy the corresponding futures contract for the S&P 500 index.
Currencies
Currency futures contracts are written in pairs. It is a promise to exchange a certain amount of one currency for a certain amount of another currency. For example, if a trader feels that the value of the US dollar will rise compared to the value of the Euro, then he will buy the USD/EUR forward that matches that feeling.
Explanation of futures trading
Retail traders and portfolio managers are usually not interested in taking delivery or taking delivery of the underlying asset. A retail trader does not need to have access to 1,000 barrels of oil, but may be interested in making a profit on the movements in the price of oil. This type of contract can sometimes be traded for profit only, as long as the deal is closed before expiration. Many futures contracts expire on the third Friday of each month, but the contracts vary greatly, which means that you should double-check the specifications of futures contracts before trading them.
Let’s say the April futures contract is trading at $55. If the trader thinks that the price of oil will rise before the contract expires in April, he can buy the contract at $55. This gives them control of 1,000 barrels of oil. However, they may not be required to pay $55,000 ($55 x 1,000 barrels) for the privilege right away. Instead, the broker only requires an initial margin payment, usually set at a few thousand dollars per contract. The profit or loss ratios of the position in the account fluctuate with the movements of the futures contract price. If the loss is great So, the broker will ask the trader to deposit more money to cover the loss and this is called the maintenance margin. The final profit or loss result of the deal is realized when the deal is closed. In this case, if the buyer sold the contract at $60, he would earn $5,000. If the price drops to $50 and he closes the position there, he will lose $5,000.
Frequently Asked Questions
Why is the forward contract called by this name?
A futures contract gets its name from the fact that the buyer and seller of the contract agree on a certain price for some asset or security that will be delivered in the future for that predetermined price.
What happens if a futures contract is entered into when it expires?
Unless the contract position is closed before it expires, the seller is obligated to deliver to the long term, and the buyer is obligated to take it. The values exchanged can also be settled in cash and most of the time, the buyer may get a cash settlement depending on whether the underlying asset has increased or decreased during the investment period. However, in some cases, futures contracts may require physical delivery. In this scenario, the trader who holds the contract at expiry will be responsible for storing the goods and will need to cover the costs of material handling, physical storage, and insurance.
Who uses futures contracts?
Speculators can use futures contracts to bet on the future price of certain assets or securities. Hedgers also use futures contracts to lock in the price and reduce market uncertainty between now and the time the commodity is delivered or received.
How can I trade these contracts?
Whether or not you qualify to trade this type of contract depends on your broker and your account status with that broker. You will need to have a margin account and be prepared to do so.
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