Futures are frequently employed in a variety of sectors to protect against price volatility and by speculators looking to profit from price swings. A futures contract gives a buyer or seller the right to buy or sell a certain product at a predetermined price in the future.
There are different types of futures, both in the financial and commodity markets. Stock, index, currency, and interest futures are examples of financial futures. Futures are also available for agricultural products, gold, oil, cotton, oilseed, and other commodities.
It's crucial to understand the difference between options and futures. American-style options contracts provide the holder with the right (but not the responsibility) to purchase or sell the underlying asset at any time before the expiration date. European options allow you to exercise your right only at expiration but do not require you to do so.
The buyer of a futures contract - on the other hand, is required to take possession of the underlying commodity (or its monetary equivalent) at the expiration date and not sooner.
A buyer of a futures contract has the option to sell their position before it expires, releasing them from their obligation. Buyers of options and futures contracts gain from a leveraged position closing before the expiration date in this fashion.
Commodities are physical assets that can be bought and sold by investors. Oil, metals, natural gas, food grains, and other commodities are among the most popular commodities for which investors purchase futures contracts. The assets themselves provide the security for such arrangements.
Commodity futures are extremely crucial for managing price risk, particularly for farmers. A farmer or main crop producer might sign a futures contract to sell his produce at a particular price at a specific date in the future. This way, he knows exactly how much he'll be paid for his work. He can be free of the fear of losing money if the price drops in the future.
Currency futures are contracts based on currency exchange rates. The contracting parties agree on an exchange rate for the exchange of two currencies at a future date. Such contracts can help to eliminate the exchange rate risk that can develop in long-term international trading. Typically, the parties will close these contracts before the expiration date in order to meet their needs.
Interest rate futures are a type of hedging against the risk of a financial instrument's rate of interest fluctuating at some point in the future. Uncertain interest rates may impose an additional financial burden on businesses, resulting in significant losses. Interest rate futures are typically used in conjunction with money market or bond market securities such as government bonds, bills, and so on. They are the assets that these futures contracts are based on.
Single stock and stock market index futures are used by investors to hedge against risks, speculate, or just trade. They are also a reflection of investor confidence and feelings in the market. Single stock futures act as a hedge against the stock's future price. Stock market index futures, on the other hand, track the movement of an index.
Stock futures are financial derivatives that create an obligation to buy or sell a stock at a certain price and on a specific date in the future. They are beneficial to investors who have a significant stake in one or a few stocks. They wish to protect their risk position in the event of a potential stock price decline.
Speculators and hedgers are the two main types of investors in futures contracts.
For example - A cocoa grower may believe that come harvest time, the commodity's price will have dropped. He could sell a futures contract at current rates to protect against perceived losses, then exit the deal by buying cocoa at lower prices near harvest time. In essence - he sold the cocoa at a higher price before purchasing it at a lower price when it was actually produced, being an advantage from the difference in selling and buying prices. Other hedgers are pension fund corporations, insurance companies, and banks.