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Investing in futures involves purchasing or selling an asset later and paying the current market price. As a trader you can ignite your future with trading using futures contract, Traders can either protect themselves against a price rise or make a profit from it. This article will cover everything you need to know regarding futures.
What Are Futures?
Futures are a type of derivative contract agreement that allows you to purchase or sell a particular commodity asset or security at a future date and for a fixed price. It can be traded on exchanges such as the CME Group. They require a brokerage account that has been approved to trade it. Below we would have future reviews that is everything you need to know about it.
It allow traders to lock in the underlying commodity or asset price. These contracts are subject to expiration dates and have prices that can be known in advance. The expiration month is what identifies it. A December gold futures contract expires, for example, Investors and traders use the term to refer to the entire asset class. They can be traded which are also future features, including:
- Commodity futures include underlying commodities like crude oil, natural gas, and corn
- Futures contracts for precious metals, gold, and silver
- U.S. Treasury Futures for Bonds and Other Financial Securities
- Futures on stock index futures that include underlying assets like the S&P 500 Index
- Futures on currency, including the British pound and the euro
It is important to distinguish between futures and options. American-style options contracts allow the holder to purchase or sell the asset before expiration. European options are limited to exercising at expiration, but you don’t have to.
On the other hand, the buyer of it must take possession at the expiration of the underlying commodity or the financial equivalent. A buyer can cancel their position at any point before expiration to be exempt from their obligation. This allows buyers to benefit from closing a leverage holder position before expiration.
Futures Contract Example
Suppose a trader wishes to speculate on crude oil prices by entering into a futures agreement in May. He expects that the price will rise by the end of the year. The December crude oil futures contract trades at $50, and the trader purchases the contract.
Oil is traded in 1,000 barrel increments. The investor now has a position of $50,000. 5 But the trader will only have to deposit a small amount with the broker as their initial margin.
The price of oil changes from May to December, just like the it’s value. The broker might ask for additional funds to be deposited into the margin account if oil prices become too volatile. This is known as maintenance margin.
The end date for the contract (the third Friday in December) is fast approaching. Crude oil prices have risen to $65. To exit the position, the trader sells his original contract. The difference is settled in cash. They make $15,000 less any broker fees and commissions ($65 – $50 = $15×1000 = $15,000).
But, if oil prices had dropped to $40, the investor would have lost $10,000 ($50-40 = $10×1000 = $10,000).
Pros and Cons
|Investors Have The Option to Speculate with Futures Prices In The Direction of the Market’s Underlying Assets Price
|It involves risks, and speculators can lose even their initial Margin (Because futures use leverage) if price swings the other way
|Traders use it to hedge against a price drop in the future market
|Investors Could Lose Favorable Price Advantages If The Price Drops Beyond The Anticipated Rate at Settlement
|Investors can save money by using leverage margin
|Using Margin also has its consequences; investors can sustain a huge loss.
Traders have two options when approaching these which are hedging or speculating.
Hedgers use it to protect themselves against the price movements of an underlying asset. It is also a guarantee of the current market price. This protects the hedger from any adverse changes in the asset’s price. Oil prices constantly fluctuate, so an oil company may enter into an oil agreement with a buyer if the current market price of oil is higher than the buyer will want to buy the oil in the future. A buyer of oil who is worried about the future price may opt to lock in the current price with a it to avoid market volatility.
Speculators use it to speculate on the future makes prices of assets to make a profit. They can either take a short or long position. A speculator might buy gold futures at a low price and then sell them back at a higher price to make a profit. If the speculator believes that the gold price is too high, they might short-sell gold futures and wait for it to fall before buying it at a lower price. Speculators make educated guesses. Speculating is a high-risk short-term trading strategy.
Is Futures a Type Of Derivative?
It can be considered a derivative products. Futures contracts are derivatives as their value is determined by the value of an underpinning asset (in this case, oil). Futures, like many derivatives, can be leveraged to make large gains or losses. they are considered advanced trading instruments and can only be traded by institutions and experienced investors.
What Is a Futures Contract
It allows you to purchase or sell an underlying asset, typically a leveraged financial instrument (or underlying commodity), at a predetermined price and time in the future. The buyer can choose to receive cash settlement rather than physical delivery of an underlying asset at the it’s expiration.
What Happens If You Hold a Futures Contract Until Expiration?
Many traders who have futures contracts that expire before they expire will settle their positions in cash. The trader will receive or pay a cash settlement depending upon whether the underlying asset has increased or decreased over the holding period.
They may require physical delivery in some instances. The investor who holds the contract at expiration would receive the underlying asset in such a scenario. They would be responsible for the goods and cover all costs related to material handling, storage, and insurance.
Initial vs. Maintenance Margin for a Futures Contract: What’s the Difference?
The value of a futures contract is derived from the cash value of the underlying asset. While it may have a very high value, a trader can buy or sell the contract with a much smaller amount, which is known as the initial margin. Below are the difference between Initial vs. Maintenance Margin for a Futures Contract:
The cash value of an underlying asset determines the value of a futures agreement. It can have a high price, but a trader may be able to buy or sell it with a lower amount, known as the initial margin. Below is the difference between the Initial and Maintenance Margin:
The initial margin refers to the initial amount of money that a trader must deposit to open a futures account. This amount is set by the exchange and is a percentage of the it’s contract’s value. Exchanges can set initial margin requirements for it as low as 5% to 10% of the contract.
The contract’s nominal value is $75,000. However, a trader is not required by law to deposit this amount into an account. The exchange determines that the initial margin for crude oil contracts could be approximately $5,000. This is the initial amount a trader must deposit in an account to open a new position
The maintenance margin amount is lower than the initial margin. This is the amount that the trader must keep in his account in case of price changes.
Assume that the maintenance margin for oil is 4,000. A trader might buy an oil contract, which drops by $2. This would mean that the contract’s value has dropped to $2,000.
The maintenance margin is the amount of money the trader must place in additional funds to cover the account’s balance. If the trader fails to meet the margin call, the broker or exchange can unilaterally liquidate the trader’s position.