futures Archives - MKTPlace https://mktplace.org/tag/futures/ all about trading, Fintech, Business, AI & technology in one place Mon, 23 May 2022 08:58:56 +0000 en-US hourly 1 https://wordpress.org/?v=6.7.2 https://mktplace.org/wp-content/uploads/2021/03/favicon.png futures Archives - MKTPlace https://mktplace.org/tag/futures/ 32 32 A Trader’s Guide to Futures – Part 2 https://mktplace.org/a-traders-guide-to-futures-part-2/ https://mktplace.org/a-traders-guide-to-futures-part-2/#respond Wed, 25 Feb 2015 07:00:09 +0000 http://www.tradersdna.com/?p=33093

In the first section of this guide we took a look at what a futures contract actually is, and how it works at a basic level. The second part of the guide will describe why exactly investors find them so useful and when they should be considered as an instrument worth investing in.

This part of the guide will give an overview of how the futures market works in aggregate, and why investors bother with it, leading on to Part 3 which will show how to assess and value futures contracts.

Why buy futures?
In part one the parties involved had their own goals. The farmer was looking to get some cash up front for his grain, the investor was looking to make a profit off of a prediction that the price of grain was set to rise. It’s important to remain on the safe side and avoid debt management by working with a professional like these insolvency practitioners London. This is one type of futures contract, but there are many different objectives and uses for such contracts. Below we list the two basic uses of a futures contract:

Hedging risks: Futures contracts allow companies and investors to stabilize the price of a volatile asset in the long term, reducing pricing risk. The airline industry is the most famous partaker of these type of contracts, with aircraft fuel constantly being fixed by various futures contracts.

In an industry highly cost sensitive to changes in a volatile asset this makes sense, though the recent drop in oil prices has many airlines stuck to contracts buying fuel way above current market price.

Instead of trying to guarantee the price of oil, some investors try to limit their downside from the bond market by investing in instruments like interest rate swaps. This means that, instead of fixing a price, the risk of losses on certain investments is lowered. This principle can be applied all over the capital markets.

Speculation: In order to take advantage of predictions about future prices, futures are often the best way to get exposure to a commodity and increase exposure using the leverage discussed in Part 1. Speculators, like our grain investor, try to make money all the time by betting on the futures markets.

In fact, all short contracts on stocks and bonds are a kind of future that work in this way. An agreement is made to sell stock of United Company Group at $10 in six months. If the price at that date is $8, the seller is able to make $2. Famous short sellers, like hedge fund managers, do this with millions of dollars at a time.

Who buys futures?
Because of the immense variety of markets that futures are available in, a vast cross section of market players are involved in buying and selling them. From companies that want to fix the price of commodities to hedge fund managers that want to short a company, to a bank that has taken on too much risk in a certain market.

Because of this, basically everyone but specialists trade futures. Commodity producers sell them in order to secure cashflow; market makers buy and sell them en masse in order to take a margin by selling them on, maintaining market liquidity; hedge fund managers buy and sell them against each other; companies hedge their costs on them; financial firms manage their risks based on them; the list goes on and on.

The whole futures market works together in this way in order to set prices for the foreseeable future, and gives a huge economic incentive to analyzing market trends in order to predict the future price of assets.

This means, because of the arbitrage dynamics, that today’s price is more representative of the market’s expectations for the future of a certain asset. The market can, of course, be wrong, but it offers a kind of price stability and predictability that allows both investors and normal companies to operate.

The next section of this guide will concentrate on how exactly you can trade futures, and what the steps are to set up your first trade.

 

Related Posts:

A Traders’s Guide to Futures – Part 1

]]> https://mktplace.org/a-traders-guide-to-futures-part-2/feed/ 0 A Trader’s Guide to Futures Part 1 https://mktplace.org/traders-guide-futures-part-1/ https://mktplace.org/traders-guide-futures-part-1/#respond Fri, 13 Feb 2015 07:00:42 +0000 http://www.tradersdna.com/?p=33013

A future is a derivative contract in which two parties agree to make a specified transaction at a particular date in the future. Buying a futures contract forms an agreement under which the investor agree to buy the underlying asset at a future date. Selling a future means taking the opposite side of that trade.
This guide is written as a general overview of the world of futures for those interested in exploring the market. Likely the most important piece of the derivatives market, the futures market offers a low cost way to bet on price changes, to hedge against those changes and to access asset markets without geographic or chronological limit.

Because of the intense multiplicity of futures contracts, it will be impossible to study any of them in any detail in this guide. Instead, reading on will offer you a broad glimpse of what futures are exactly, how they affect the market and under what circumstances they can be useful, or profitable, for investors.

The first part of the guide will concentrate on what futures are exactly, and why they differ from the more talked about financial instruments.

What are Futures?
Futures are, at their most simple, contracts selling goods that have not yet been produced. A farmer may decide to sell his entire crop production before realizing it, in order to get cash up front. In order to do this, it will have to be sold at a lower value than the expected yield. If a contract is struck, cash changes hands on Day 1, while crops don’t change hands until the agreed delivery date. The buyer of the contract takes on all of the risk of the transaction.

This is, in fact, the exact situation under which the futures contracts of today evolved. A farmer’s cash supply is extremely limited throughout the year, and futures allowed financial planning based on an agreed price for crops, and a way to ensure cash-flow if major expenses should come up.

Grain is still heavily traded through futures contracts, and farmers still face the exact same problems they did a century ago. Many other assets have been added to the market, however, from the obvious commodities, like fruit, vegetables, beef and oil, to the more abstract, like bonds, company stock and other derivatives.

A future is a type of derivative, meaning that it is a contract that refers to an actual asset. Its price moves with the underlying asset, in this case grain, but the actual asset isn’t traded or directly connected to the contract. There is no specific ton of corn that must be delivered on the expiry date.

The important difference between the grain contract struck by the farmer and today’s futures is that today’s instruments can be traded openly. The futures market is very liquid in most cases, allowing you to buy and sell contracts without having to worry about storing a ton of grain.

Leverage and futures
Leverage means debt, and one of the most powerful features of futures contracts is the ability to pay for them in part, leaving the balance of payment outstanding until some future date, often the same as the expiration of the contract. A short example will illuminate the power of leverage while giving an insight into the workings of a futures contract.

Day One: a contract is struck putting the price of a ton of grain at $100. The Buyer, or Investor, agrees to pay the Seller, or Farmer, $10 upfront and the remainder on the Expiry Date, or harvest.

If the weather is worse than expected and the price of grain jumps to $110 per ton a few weeks later, the buyer will be able to sell the contract for that amount, less the $90 outstanding, and make a $10 profit. With the contract sold, he has no more obligation to the farmer so the total investment was $10.

Leverage allowed the investor to make a 100% return. The margin on this investment was 10% allowing a multiple of 10 on all returns. If the margin was 5% it would have allowed a multiple of 20, but both buyer and seller would have to agree to the margin. In practice, margins on futures are decided on by the brokerages that sell them for the most part.

Astute observers will have noticed that if the price of grain fell, let’s say to $90, on the above contract, the Investor would have lost his entire investment. If it had fallen even lower, the Investor would have been forced to pay out more than he invested in the first place. This is called a margin call, and it is what makes leverage such a powerful and risky tool for investors.

Futures summary
-A future is a contract whereby the seller agrees to sell some asset to the buyer at a specified date.

-Futures can be traded openly at any time up to the expiration date, at which the difference must be settled.

-Futures can be leveraged, or bought on credit, meaning returns can be magnified and investors can lose more than they initially invested.

 

Related article:

A Trader’s Guide to Futures: Part 2

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