Futures Contract
A futures contract is a legal agreement to buy or sell a particular commodity or financial instrument at a predetermined price on a specified future date. It allows businesses to hedge against price fluctuations and manage risk. Futures contracts are commonly used in industries such as agriculture, energy, and finance to lock in prices and protect against market volatility.
8 Key excerpts on "Futures Contract"
eBook - ePubThe Investor's Toolbox
How to use spread betting, CFDs, options, warrants and trackers to boost returns and reduce risk
- Peter Temple(Author)
- 2012(Publication Date)
- Harriman House(Publisher)
...3. Futures Many investors imagine that futures are complex and risky, and therefore not for them. But if you’ve lost money in technology shares, as many investors have in the last few years, or simply held a share in a company that issued a profit warning, you know that shares can be risky too. Futures are, in fact, quite simple. It is only the jargon that makes them complicated. Basic futures Although futures do involve gearing, you can also look at them as a way of investing using modest amounts of capital. The important point is to have good trading discipline and an efficient way of limiting your losses. Rather than get ahead of ourselves, let’s recap what we already know. In Chapter 2, we discovered that derivatives are contracts. This means they are legally enforceable agreements. The derivative part comes because their price is based on (derived from) the movement of an underlying variable like a share or a stock market index. A future is a binding agreement to buy or sell a specific quantity of a commodity (or share, or index, or some other instrument) at the market price prevailing at some predetermined point in the future. There is no fixed price element in the contract, other than the price at the time delivery is scheduled to take place. But the point about a future is that it isn’t an agreement with anyone in particular. It is not a bilateral agreement with another person or company. You buy a Futures Contract from anyone and sell it to anyone, via an exchange. You never know, or need to know, who that other buyer or seller might be. Futures contacts are standardised Futures Contracts are tradable because they are standardised. This standardisation is to eliminate any other possible factor – other than the underlying price – that might affect the value of the contract, and to allow traders to trade a standardised product with similar terms – without having to check all the terms of the contract. Here’s an example from real life...
eBook - ePubCommodities and Commodity Derivatives
Modeling and Pricing for Agriculturals, Metals and Energy
- Helyette Geman(Author)
- 2009(Publication Date)
- Wiley(Publisher)
...But they have from the start been providing a hedging vehicle against price risk : a farmer selling his crops in January through a Futures Contract maturing at time T of the harvest (say, September) for a price F T (0) defined on 1 January has secured at the beginning of the year this amount of revenue. Hence, he may allocate the proceeds to be received to the acquisition of new machinery or storage facilities and, more generally, design his investment plans for the year independently of any news of corn oversupply possibly occurring over the 9-month period. It is noticeable in many markets, ranging from agricultural commodities to electricity, that Futures Contracts are used as a substitute for the spot market by hedge funds, Commodity Trading Advisors (CTAs) or any class of investors wishing to take a position in commodities, both because it takes away the physical constraints of spot trading and provides the flexibility of short and long positions, hence the choice of positive or negative exposure to a rise in prices. This will be discussed in detail in Chapter 14. What follows describes in detail the mechanisms of forward and Futures Contracts with their various characteristics as well as the way exchanges operate. The different classes of participants, the mechanism of price discovery and the crucial relationships, if they exist, between spot prices and Futures prices under some form of equilibrium assumptions are described in detail. Forward contracts A forward contract is an agreement signed between two parties A and B at time 0, according to which party A has the obligation of delivering at a fixed future date T an underlying asset and party B the obligation of paying at that date an amount fixed at date 0, denoted F T (0) and called the forward price for date T for the asset. Note that this price is not a price in the sense of the price of a stock, but rather a reference value in the contractual transaction...
eBook - ePubInterest Rate Markets
A Practical Approach to Fixed Income
- Siddhartha Jha(Author)
- 2011(Publication Date)
- Wiley(Publisher)
...However, if he chooses to sell a forward contract on corn with the forward date around the harvest period, he can deliver the corn at harvest time at the price agreed to today. Since the contract fixes this price for the farmer, it reduces his exposure to corn price volatility in the meantime. (See also Chapter 8 on hedging.) BASICS OF FUTURES TRANSACTIONS Futures markets started out as forward markets on agricultural goods and other “real” assets. These markets allowed farmers and other participants to buy and sell goods at a forward basis at a fixed price to reduce risk. By virtue of their standardization, futures exchanges provided a more liquid, transparent way to match buyers and sellers instead of individual pairings. The futures exchanges also provided a legal framework to allow buying and selling goods without the fear of counterparties engaging in foul play or defaulting on promised goods. As markets grew and the financial sector gained prominence, the need arose for financial futures, such as interest rate futures and futures related to equities. In particular, as interest rates became increasingly volatile in the late 1970s, financial futures proved to be very popular with investors to hedge interest rate risk. For example, a natural extension from the existing commodity futures was Treasury futures, where bonds were delivered instead of corn or wheat. Today, the underlying assets in futures markets cover an enormous range with most of the basic guiding principles of the early Futures Contracts still intact. Regardless of underlying product, the Futures Contract represents a binding agreement to buy/sell an asset at a forward date at a price agreed upon today. An attractive feature of the futures markets is the ability for a buyer or seller to get large exposure to the market with little up-front cash. This stems from the margin concept, which accompanies all Futures Contracts such that neither party pays the actual quoted price of the asset...
eBook - ePubUnknown Market Wizards
The best traders you've never heard of
- Jack D. Schwager(Author)
- 2020(Publication Date)
- Harriman House(Publisher)
...Appendix 1: Understanding the Futures Markets 23 What Are Futures? T he essence of a futures market is in its name: Trading involves a commodity or financial instrument for a future delivery date, as opposed to the present time. Thus, if a cotton farmer wished to make a current sale, he would sell his crop in the local cash market. However, if the same farmer wanted to lock in a price for an anticipated future sale (e.g., the marketing of a still unharvested crop), he would have two options. He could locate an interested buyer and negotiate a contract specifying the price and other details (quantity, quality, delivery time, location, etc.). Alternatively, he could sell futures, which provide multiple attributes. Advantages of Futures Some of the major advantages of futures markets for the hedger are: The Futures Contract is standardized; hence, the farmer does not have to find a specific buyer. The transaction can be executed virtually instantaneously online. The cost of the trade (commissions) is minimal compared with the cost of an individualized forward contract. The farmer can offset his sale at any time between the original transaction date and the final trading day of the contract. The Futures Contract is guaranteed by the exchange. While hedgers, such as the aforementioned cotton farmer, participate in futures markets to reduce the risk of an adverse price move, traders participate in an effort to profit from anticipated price changes...
eBook - ePubCommodity Derivatives
A Guide for Future Practitioners
- Paul E. Peterson(Author)
- 2018(Publication Date)
- Routledge(Publisher)
...Unlike other financial instruments such as stocks or bonds for which there is a fixed number or dollar amount of a security, the number of Futures Contracts for a particular commodity at a particular time is limited only by the willingness of buyers and sellers to trade with each other. A Futures Contract is created each time a new buyer and a new seller make a transaction, so at any time prior to expiration the amount of a commodity represented by Futures Contracts is unrelated to – and frequently exceeds – the amount of the underlying commodity actually in existence. This is possible because Futures Contracts are derivatives and not the actual commodity. Because Futures Contracts are standardized, a seller wishing to “buy back” the Futures Contract created in an earlier sale, or a buyer wishing to “sell back” a Futures Contract created in an earlier purchase, does not need to find the original buyer or original seller and get them to agree to reverse the original transaction. Instead, a seller or buyer can trade with anyone, because all terms and conditions of the new Futures Contract are identical to those of the original Futures Contract, except the price. This is the reason why all Futures Contracts for the same commodity and expiration date are fungible, or interchangeable. Long and Short Positions A person can first buy a contract – called going long or taking a long position – and then sell the same contract later to liquidate the long position, or a person can first sell a contract – called going short or taking a short position – and then buy the same contract later to close out the short position. While it might seem strange that a person can sell or “short” something they don’t own, taking a particular futures position, long or short, is not dependent upon a person’s holdings of the underlying commodity...
eBook - ePubForeign Exchange
A Practical Guide to the FX Markets
- Tim Weithers(Author)
- 2011(Publication Date)
- Wiley(Publisher)
...As such they may be tailored in any way that the two parties see fit. This means that they may (and actually must) specify the amount (or notional or face), the (forward) price, the type, nature, quality of the underlying, the mechanism for delivery (timing, location), and possibly some additional features as part of the contract. Futures Contracts are standardized contracts; that is, they specify the amount, typically quote the price in certain minimum increments, identify the nature or quality of the deliverable asset, have set maturities and delivery dates (or delivery windows), and well-defined delivery processes. Some exchanges have attempted to mitigate the replacement of their exchange-traded contracts with the more flexible OTC contracts, which might better suit the end users’ financial, economic, or accounting needs by allowing some relaxation of the standardized features of the exchange-listed contracts especially when it comes to exchange-listed options contracts: these are sometimes identified as “flex” contracts. As an example, a flex contract might allow for endof-month settlement (to accommodate financial statement reporting considerations) as opposed to the exchange convention, which does not coincide with the final day of the calendar month. Another variation might involve physically settling a cash-settled contract. 3. The third difference between forwards and futures has to do with cash flows. When one buys or sells a future, the transaction is actually done between members of the exchange. These may involve brokers acting on behalf of customers, locals trading their own financial capital, or any of the members of the exchange (which could represent larger banks and broker/dealers). Once a transaction is agreed upon, executed, and confirmed, though, the exchanges and clearing houses act as the counterparties to both sides of the trade...
eBook - ePubFutures Markets (Routledge Revivals)
Their Establishment and Performance
- Barry Goss(Author)
- 2013(Publication Date)
- Routledge(Publisher)
...The commercial demand for Futures Contracts is seen as coming from hedgers and speculators. A potential hedger is one who is confronted by price volatility and a ‘price risk’ — the chance that the price will move in an unfavourable direction. The hedger enters the futures market in order to transfer the price risk to another party. In doing this the hedger replaces the price risk with a basis risk — that spot and futures prices will not move in parallel. If the price spread between spot and futures prices is constant at the time the contract is sold, and when it is bought the hedge is said to be perfect, then the risk (both price and basis) is eliminated. A short hedger is one who sells a Futures Contract and incurs a liability to deliver the ‘commodity’ during the maturity month of the contract at the price prevailing when the initial transaction took place. If the contract is settled by delivery, the net change in the value of the asset is the original futures price minus the spot price during the delivery month. Typically the seller of a Futures Contract will offset his obligation to deliver by the purchase of a Futures Contract, thus extinguishing his net obligations to the market. If this is done, the net change in the value of the asset due to futures trading is the difference in the two futures prices. A long hedger or buyer of a Futures Contract confronts the mirror-image of these changes. The extent to which the price of a forward Futures Contract can exceed the spot price (called a contango) is limited by arbitrage. The maximum difference cannot exceed the marginal cost of storage until maturity plus delivery costs. A larger contango would give arbitrageurs a riskless profit by buying in the spot market and simultaneously selling futures. The extent to which the spot price exceeds the futures price, called a backwardation, is not necessarily constrained by arbitrage...
eBook - ePubDerivatives
Theory and Practice
- Keith Cuthbertson, Dirk Nitzsche, Niall O'Sullivan(Authors)
- 2019(Publication Date)
- Wiley(Publisher)
...With a forward contract, delivery usually takes place, whereas with a Futures Contract you do not necessarily have to take delivery of the currency because you can easily close out your position before maturity. If you are long a currency futures and you decide not to take delivery, then you can close out your position by selling the futures (on the same currency and with the same maturity date). The FX-Futures Contract is marked-to-market daily (which involves margin payments) and therefore has virtually zero credit risk, whereas the forward contract involves counterparty credit risk. Currency forwards and futures are used to hedge future cash flows in foreign currency – for example, by exporters and importers. Similarly, they are used to hedge future cash flows from purchases or sales of capital assets such as foreign bonds and stocks as well as future interest cash flows from foreign bank deposits or loans. They also provide leverage in speculative FX-transactions, which are gambles on the future path of exchange rates. 7.1 FX-Futures ContractS 7.1.1 Contract Specification There are a large number of currency futures traded on different exchanges, the major one being the International Money Market (IMM) division of the Chicago Mercantile Exchange (CME). For example, on CME the following currencies are traded against the US dollar: pound sterling, euro, yen, Swiss franc, Canadian dollar, Australian dollar, Mexican peso as well as other currencies. Other notable centres trading FX-futures are the Singapore International Money Exchange (SIMEX) and the Sydney Futures Exchange (SFE). On CME there are also futures on the major cross rates. The most actively traded Futures Contracts traded on the CME are in the euro, Canadian dollar, Japanese yen, Swiss franc and sterling. Details of some of these contracts are given in Table 7.1...
