What are Future Contracts
Have you ever heard of a futures contract? It’s an agreement that obligates you to buy or sell a specific amount of a particular asset or commodity at a predetermined price on a future date. Since the terms of futures contracts are standardized, they can be traded on an exchange. The only variable is the price. You’ve probably heard of many of the commodities and financial instruments that futures contracts represent, such as oil, corn, gold, popular stock indices, and foreign currencies. Futures trading takes place on regulated exchanges that serve as a platform for buyers and sellers to trade and clear their transactions. In the US, futures trading has been around since the mid-1800s, when it was used to connect cotton and grain producers with their users. Today, the largest futures exchange globally is CME Group, whose stock is listed on the New York Stock Exchange. When you trade futures, each transaction creates a new contract, and there is no limit to the number of contracts that can be created. In contrast, there is a limited number of shares of stock available for trading in each publicly listed company.
Speculators
Speculators are individuals who use their market outlook to take positions in derivatives. For example, if Aisha believes the market will rise, she would take a long position in a Futures contract by securing a purchase price now. On the other hand, if she predicts a market decline, she would take a short position. Speculators wager on potential market movements.
Hedgers
Investors who want to safeguard their investment portfolios during unstable times use Futures contracts for hedging. To minimize risk, they typically take opposing positions in different contracts on the same underlying. Hedging is a strategy employed to decrease current business risk, and it is commonly used by corporates, banks, financial institutions, and individuals who want to mitigate their risks in various variables such as shares, bonds, interest rates, currencies, and commodity prices.
Arbitrageurs
Arbitrage is an investment strategy that takes advantage of price differences for the same asset in different markets. This involves selling overpriced Futures contracts and buying the same amount of stock in the cash market, resulting in a risk-free profit. Arbitrage can occur between different exchanges or between spot markets and derivatives using Futures. The underlying principle is that if an asset provides equal benefits, its price should be the same across different markets. Any deviations from this provide arbitrage opportunities, which the investor can capitalize on by buying where the asset is cheaper and selling where it is more expensive.