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Futures

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Isaac Alexis Rivera
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9 views4 pages

Futures

Uploaded by

Isaac Alexis Rivera
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Futures: An Overview

What are Futures?

Futures are financial contracts obligating the buyer to purchase, or the seller to sell,
an asset at a predetermined future date and price. They are standardized contracts
traded on futures exchanges, used for hedging or speculative purposes.

Types of Futures

Commodity Futures

These futures contracts are based on physical commodities such as oil, gold, natural
gas, agricultural products (like corn, wheat, and soybeans), and metals.

Financial Futures

These contracts are based on financial instruments, including stock indices, interest
rates, and currencies. Examples include:

 Stock Index Futures: Based on indices like the S&P 500 or NASDAQ.
 Interest Rate Futures: Based on government bonds or Treasury bills.
 Currency Futures: Based on currencies like the USD, EUR, or JPY.

Key Terms in Futures Trading

Contract Size

The standardized amount of the underlying asset specified in the futures contract.

Expiration Date

The date on which the futures contract must be settled, either through delivery of
the underlying asset or by cash settlement.

Initial Margin

The initial deposit required to enter into a futures position, serving as a guarantee
for the contract.

Maintenance Margin

The minimum account balance that must be maintained to keep a futures position
open. If the account falls below this level, a margin call is issued.

Settlement
The process of fulfilling the obligations of the futures contract at expiration. This can
be done through physical delivery of the asset or cash settlement based on the
asset's price.

How Futures Work

Futures Exchanges

Futures contracts are traded on regulated exchanges, such as:

 Chicago Mercantile Exchange (CME)


 Intercontinental Exchange (ICE)
 Euronext

Mark-to-Market

Futures accounts are marked-to-market daily, meaning gains and losses are settled
at the end of each trading day. This ensures that the account balance reflects the
current market value of the futures position.

Leverage

Futures trading involves significant leverage, as only a fraction of the contract's value
(the margin) is required to enter a position. This amplifies both potential gains and
losses.

Strategies Involving Futures

Hedging

Businesses use futures to lock in prices for commodities they need to buy or sell,
protecting against adverse price movements. For example, a farmer might sell
futures contracts on their crop to ensure a favorable selling price at harvest.

Speculation

Traders use futures to profit from anticipated price movements in the underlying
asset. Speculators take long (buy) or short (sell) positions based on their market
outlook.

Spread Trading

Involves simultaneously buying and selling related futures contracts to profit from
changes in the price difference (spread) between them. Common strategies include
calendar spreads and inter-commodity spreads.

Arbitrage
Traders exploit price discrepancies between related markets or instruments, such as
the spot market and futures market, to make risk-free profits.

Risks Associated with Futures

Market Risk

The risk of losses due to adverse price movements in the underlying asset.

Leverage Risk

The use of leverage amplifies both potential gains and losses, increasing the risk of
significant losses.

Margin Risk

The risk of margin calls if the account balance falls below the maintenance margin,
requiring additional funds to maintain positions.

Liquidity Risk

The risk that a futures position cannot be easily closed at a fair price due to low
market activity.

Benefits of Trading Futures

Price Discovery

Futures markets contribute to price discovery by reflecting supply and demand


dynamics for the underlying asset.

Hedging

Futures provide an effective tool for managing price risk, allowing businesses to
stabilize costs and revenues.

Liquidity

Futures markets are highly liquid, enabling large positions to be entered and exited
with minimal impact on prices.

Leverage

Futures allow traders to control large positions with relatively small amounts of
capital, offering the potential for substantial returns.

Futures Market Indices


Futures market indices track the performance of specific futures markets or
segments, providing insights into market trends. Major indices include:

 Bloomberg Commodity Index (BCOM): Tracks a diversified basket of commodity futures.


 S&P GSCI (Goldman Sachs Commodity Index): Represents a broad measure of commodity
market performance.
 CBOE Volatility Index (VIX): Measures market expectations of near-term volatility conveyed
by S&P 500 stock index option prices.

Conclusion

Futures are versatile financial instruments that play a crucial role in risk management
and speculation across various markets. Understanding the types of futures, key
terms, trading strategies, and associated risks is essential for making informed
decisions in futures trading. Whether used for hedging or speculative purposes,
futures offer numerous opportunities to align with diverse investment objectives.

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