Risks of Futures

What are Futures?

Futures are financial derivative contracts in which the parties are obliged to purchase or sell an asset at a price and date that are fixed in the future. The underlying asset must be purchased or sold at the agreed-upon price, regardless of its current market value as of the expiration date. Financial instruments and physical commodities are examples of assets under Futures. Futures contracts enable investors to secure a predetermined price for the underlying commodity or asset. For example, assume a coffee farmer is worried about a possible reduction in coffee prices. They can hedge against this risk by selling coffee futures contracts, which lock in a selling price for their coffee. If the actual market price falls, the physical market losses will be offset by profits in the futures market. These contracts are defined by predetermined costs and expiration dates. The identification for futures are expiration months. For instance, the expiration date of a December gold futures contract is December....

Use of Futures

1. Hedging: Commodity producers and consumers frequently utilise futures contracts to hedge against price volatility. A farmer, for example, can use a maize futures contract to lock in a price for their crop before it is harvested, protecting themselves from any price drops....

Why Trade Futures?

Trading futures provides multiple benefits to market participants, and people trade futures for a variety of reasons. Here are some of the main reasons traders prefer to trade futures:...

Types of Futures

Futures contracts are classified according to their underlying assets and financial instruments. Here are some examples of common sorts of futures:...

Examples of Futures

An agreement exists for an American importer to acquire products from an Indian supplier Madhav Ltd. The transaction shall be settled in Indian Rupees, and the importer based in the United States is anxious regarding possible volatility in the INR/USD exchange rate. In anticipation of unfavourable currency fluctuations, the importer opts to employ an INR/USD futures agreement as a hedge....

Pros of Futures

Pros of Futures Trading Explanation Hedging Opportunities Hedgers can use futures to protect themselves against price volatility, lowering the risk associated with swings in commodity or financial prices. Speculative Profits Traders can earn from both bull and bear markets, which provide opportunities for speculation as well as potentially better rewards. Price Discovery Futures markets help to price discovery by reflecting market participants’ collective expectations and opinions. Leverage Futures contracts frequently require a percentage of the contract value as margin, giving traders the ability to control larger positions. Liquidity Many futures markets are highly liquid, enabling traders to easily enter and exit positions while minimising transaction costs....

Cons of Futures

Cons of Futures Trading Explanation High Risk and Volatility Futures trading involves significant risk and can be highly volatile, leading to substantial financial losses. Margin Calls Because futures traders utilise leverage, they may suffer margin calls, which require additional funds to cover possible losses. Complexity Understanding futures agreements, market dynamics, and different strategies can be difficult, necessitating a substantial amount of monetary knowledge and expertise. Limited Predictability Market movements can be unpredictable, making it challenging to accurately forecast price changes and time entry or exit points. Counterparty Risk There’s a risk associated with the counterparty in futures transactions, particularly if the other party fails to meet its contractual obligations....

What are Futures Contracts?

A futures contract is a standardised contractual arrangement between two parties to purchase or sell an item at a fixed future date for an agreed-upon price established today. These contracts are exchanged on regulated futures markets and encompass a diverse array of assets, such as commodities, securities, stock indexes and others....

Risks of Futures

1. Leverage Risk: The use of leverage increases both profits and losses. Although it boosts the possibility for profit, it also elevates the chance of substantial financial losses....

Difference Between Options and Futures

Basis Options Futures Contract Type Grants the holder the right, without imposing any duty, to purchase or sell the underlying asset at a specified price. Obliges both parties to fulfill the contract by buying or selling the underlying asset at a predetermined price. Obligation Holder has the choice to exercise or not exercise the option. Both parties are obligated to fulfill the contract terms. Risk Limited to the premium paid for the option. Potentially unlimited, as both gains and losses can be substantial. Market Direction Depending on the type of option, it allows you to profit from price changes that are either up or down. Profits can be made from both upward and downward price movements. Profit Potential Unlimited potential profit if the market moves favorably. Limited to the difference between the entry price and the market price at expiration. Cost Options involve the payment of a premium to the option seller. Initial margin payment is required before entering into a futures contract. Frequent modifications may be required due to market conditions. Common Use Used for hedging, speculation, or generating income. Used for hedging and speculation on future price movements. Flexibility Provides flexibility because the holder can choose whether or not to exercise the option. Less flexible as both parties are generally obligated to fulfill the contract. Expiration Options have a limited lifespan and expire on a specific date. Futures contracts have expiration dates, but new contracts are continually issued. Examples Call and put options. Contracts on commodities, financial instruments, or indices....