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Futures Contract

For investors trying to diversify their portfolios by investing in other asset classes, derivative trading has shown to be extremely beneficial. Some people favour options trading, while others prefer futures trading. However, due to the intricacy of futures contracts, you must be familiar with all aspects of the financial instrument.

What is a Futures Contract?

Forward and futures contracts are financial products that allow market players to reduce or eliminate the risk of an asset's price fluctuations over time.

In two fundamental respects, a futures contract differs from a forward contract: first, a futures contract is a legally binding agreement to purchase or sell a standardized asset on a certain date or during a specific month. Second, a futures exchange is used to effectuate this transaction.

Futures contracts are essential for commodity producers, consumers, traders, and investors since they are standardized and exchange-traded.

Futures Contract Explained

Futures are financial derivative contracts that obligate parties to transact the asset at a pre-determined future date and also a price. The buyer needs to buy or they sell needs to sell the underlying asset at a price - regardless of the current market price at the date of expiration

Underlying assets are inclusive of physical commodities or other financial tools. These contracts detail the quantity of the underlying asset and are standardized to facilitate trading on a futures exchange. 

Futures could be used for hedging and trade speculation.

Futures contracts and futures mean the same thing. Futures contract example - you would hear someone say they had just bought oil futures, and that means the same thing as an oil futures contract. When someone says futures contract, they usually mean a specific type of future like oil, gold, bonds, or S&P 500 index futures. 

Futures contracts are also the most direct ways to invest in oil. The terminology, futures, is more usual, and it is often utilized to the whole market - such as, they are a futures trader.

Futures contracts are standardized, unlike a forward contract. Forwards are quite similar to the types of agreements that lock in a future price in the present. But, the forwards are traded over the counter and also have customizable terms that are arrived at between the counterparties.

Futures contracts - on the other hand, would each have the same terms regardless of who the counterparty is.

Also Read: What is Futures and Options

Attributes of a Futures Contract

The table below talks about the features of futures contracts:

1) Regulation:

The commodity futures market in our country is regulated by FMC (Forward Markets Commission). It regulates aspects like withdrawing or giving recognition to any commodity market that is engaged in forward dealing.

2) Availability:

Futures contracts are available in different types of asset classes; a futures contract could work across exchanges, commodities or currencies, and indices.

3) Margin:

Since futures are traded on margin trading, they let the ones without sufficient funds carry out orders and participate in trades. One could do so by paying a smaller margin than the whole value of the physical holding.

4) Market Participants:

These contracts are employed by two main market participants : speculators and hedgers. Those who produce or buy an underlying asset hedge are known as producers or hedgers. They also guarantee the price at which the commodity would be bought or sold. Alternatively, those that bet on the price movements of the asset through the use of futures are called speculators.

Example of a Futures Contract

For instance, if an oil producer wants to sell oil but fears the oil prices will fall in the future. In order to make sure that the oil producer gets a pre-determined price and does not incur a loss, a futures contract could be used. With the assistance of future contracts, the oil producer could also lock in the price where the oil would sell - thereby delivering the oil to the buyers, and it would be once the futures contract expires.

A manufacturing company - on the other hand, would need oil to use for the manufacture of widgets. Since the company prepares well by planning ahead and chooses to have oil coming in each month, they would also employ the use of a future contract. 

This way, the company knows the price for what they will receive oil according to the price that has been set in the futures contract.

Also Read: How to Trade in Futures and Options

Trading of Futures Contracts

Futures contracts could be traded purely for profits and as long as the trade is closed before the expiry date. A lot of futures contracts will expire on the third Friday of the month - but the contracts do vary. So, you need to check the contract's specifications before trading them.

Futures Contract - FAQs

Q1. Why are they called futures contracts?

A futures contract is named from the fact that the buyer and the seller of the contract are agreeing to a price of today for an asset or security that is to be delivered in the future.

Q2. Are futures contracts a good investment?

Futures are a good instrument to hedge and manage risks. When someone is already exposed to or makes money through speculation - it is primarily due to their desire to hedge risks.

Q3. What does it mean to sell futures contracts?

Selling a futures contract is the legal agreement to sell a specific commodity asset or security at a predetermined price.

Q4. Are futures and forwards the same thing?

They are two types of derivative contracts that function similarly, but their distinction is that futures are exchange-traded with standardized contract specifications, and forwards are traded over the counter.

Q5. What happens when I buy a futures contract?

Buying futures contracts let the investor speculate on the direction of a security, commodity, or even a financial instrument - either long or short using leverage.

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