How Do Futures Work?
Futures are financial derivative contracts that bind parties to buy or sell an asset at a specified future time and price. Regardless of the market price at the date of expiration, the buyer or seller must buy or sell the underlying asset at the agreed-upon price.
Physical commodities and financial instruments are examples of underlying assets. Futures contracts are standardized to make trading on a futures exchange easier and specify the quantity of the underlying asset.
Futures are used to protect against losses from unfavorable price changes by hedging the price movement of the underlying asset.
futures contract can help to offset that loss.
The prices of futures contracts settle at the conclusion of each trading session on a futures exchange.
American-style options contracts give the holder the freedom to buy or sell the underlying asset at any time prior to the contract’s expiration date. The only time you can exercise a European option is at expiration, but you are not required to do so.
On the other hand, the buyer of a futures contract is required to take possession of the underlying commodity (or its equivalent in money) at the time of expiration and not earlier. A futures contract’s buyer is released from their obligation if they sell their position before the contract expires.
In this way, a leverage holder’s leverage is used to the advantage of buyers of both options and futures contracts.
Speculative Futures
A trader can make predictions about the course of a commodity’s price using a futures contract.
The futures contract—the long position—would be sold at the current price prior to expiration, thereby completing the long position.
There would be no physical exchange of the product; instead, the difference in the prices would be settled in cash in the investor’s brokerage account. The trader could, however, also suffer a loss if the commodity’s price fell below the futures contract’s specified purchase price.
Typical Futures
Let’s say a trader decides to make a prediction about the price of crude oil by signing a futures contract in May and hoping that the price will rise by year’s end. The trader purchases the December crude oil futures contract at the current price of $50.
Due to the fact that crude oil is traded in 1,000-barrel increments, the investor now holds a position worth $50,000 worth of crude oil (1,001 x $50 = $50,000).
The initial margin that the trader deposits with the broker will be the only portion of that sum that must be paid up front.
The price of oil varies from May to December, and so does the value of the futures contract. If the price of oil becomes too erratic, the broker may
Conclusion
To conclude, futures contracts are an excellent way of hedging against future price increases in an asset. They are also useful for speculators since they can trade in large volumes without digging deep into their capital.
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