In the world of finance, futures are an important and widely-used tool for traders and investors, but exactly what are futures contracts? Futures contracts allow people to buy or sell an underlying asset at a predetermined price at a future date. This can be helpful in managing risk, hedging against price fluctuations, and speculating on the future price movements of an asset. In this article, we will explore what futures are, how they work, how to trade futures, and why they are important.
What Are Futures?
Futures are a type of financial contract that obligate the buyer to purchase an underlying asset or the seller to sell an underlying asset at a predetermined price on a future date. These assets can include commodities like gold or oil, financial instruments like stock indices or currencies, interest rates and more. The predetermined price and future date are agreed upon at the time the contract is created, which means that both parties are locked into the transaction.
How Do Futures Work?
Futures contracts are traded on exchanges, which are marketplaces where buyers and sellers come together to trade assets. When a buyer and seller agree to a futures contract, they do not exchange the underlying asset immediately. Instead, they agree to exchange the asset at a specified date in the future, which is called the delivery date or expiration date.
Each futures contract has a set size, expiration date, and underlying asset. For example, a futures contract for crude oil might have a size of 1,000 barrels, an expiration date of December 2023, and an underlying asset of West Texas Intermediate (WTI) crude oil.
Futures contracts are often used by investors to manage risk or speculate on the direction of markets. For example, a farmer might use futures contracts to lock in a price for their crops before they are harvested. This helps to reduce the risk of price fluctuations in the market. A trader might use futures contracts to speculate on the price of a commodity, currency, or stock index.
When a futures contract expires, the buyer and seller are obligated to fulfill their obligations. If the buyer wants to take delivery of the underlying asset, they can do so by paying the agreed-upon price. If the seller wants to deliver the underlying asset, they can do so by receiving the agreed-upon price. However, many futures contracts are settled in cash, which means that the buyer and seller do not actually exchange the underlying asset. To avoid taking delivery of the underlying asset at the expiration date, an investor must either roll-over or close out their contracts beforehand.
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