Understanding Futures Contracts
In economics, a futures contract is an international customary agreement, typically a standard legal agreement, to purchase or sell something in a defined period of time in the future, involving specific parties not necessarily associated with each other, to buy or sell a product at a pre-determined price at that time. The main asset traded is usually an economic or commodity item. Futures contracts are leveraged instruments that allow traders and institutions to speculate on future price movements of particular assets. Traders use the information they obtain from the contract to exploit natural factors that may affect the price of the asset in question. Interest rates, stock exchanges, and commodity markets are all possible areas of future contract trading.
A futures contract differs slightly from currency exchange trading by the fact that commodities do not normally cross physical boundaries. However, financial instruments such as bonds, securities, and derivatives do. Futures contracts were used as collateral in forex trading before electronic trading became widespread. Since then, financial instruments have included commodities as well, although futures contracts remain the most popular.
Futures contracts are traded on futures exchanges, also called futures exchanges. Futures exchanges trade contracts for a variety of assets. Commodity exchanges include agricultural products, energy, precious metals, and options. Financial instruments traded on these exchanges include stock indexes, interest rates, currencies, and commodities.
Investors in futures markets can trade either long or short. A long position, also known as a bull market, occurs when the value of the futures product rises over time. It may happen because the product itself increases in value as time goes by. A short position occurs when the investor receives a profit from selling futures early, before the price increases to a level that makes it possible to purchase the commodity and resell it later.
Speculators buy an option on a particular commodity futures contract and hope that the price will rise over time. If the price rises, the speculator can sell the option at a profit. If the price falls, the speculator must sell the option. Some common option contracts traded on the futures exchanges include corn futures, soybean futures, wheat futures, cotton futures, and natural gas futures.
Futures contracts are not the only financial contracts available on futures exchanges. The list includes commodities that generally don’t fluctuate that much, like gold and silver. Commodity futures provide buyers with a stable source of income. For example, if the prices of certain commodities fall by a specified amount, the buyer will be able to sell his commodity futures for delivery after the predetermined future date. This means that he will earn some money should the price drop to that point. He just has to wait for the commodity’s market price to reach the price at the agreed upon date.
Futures contracts are leveraged futures contracts. This means that the buyer is required to purchase more futures than he actually need to ensure that he earns a profit when the prices drop below the specified future date. Leverage means that the more futures a particular person buys, the higher his risk. If the buyer purchases too many futures, he may be unable to sell all his assets in one transaction, and therefore lose money.
Futures brokers play an important role in the futures market. A futures broker provides advice to both novice and experienced futures traders. Futures brokers determine whether to maintain a long or short position in a particular asset during trading. In addition to advising their clients on whether to maintain a long or short position, the futures broker also ensures that the client is not exposed to too much risk of loss. The futures broker will ensure that the client does not exceed the maximum leverage level allowed by the exchange.