Futures contract. Futures - what is it?
In today's market there is a huge variety of ways to make money - even by acquiring assets that you don’t need at all. For profit it is enough to sell them at a higher cost in a good period. As far as this activity is popular and safe, we will talk in the article below.
Futures contracts: the concept and application
Futures - what is it? This is the most popular way to insure your own risks, having a high level of liquidity in the exchange market. Therefore, no large company with an international reputation has long been without this financial instrument.
A futures contract is a document that coordinates the process of buying or selling an asset. As a rule, when concluding such agreements, both parties to the transaction agree only on two key points: the timing of potential deliveries and the price of the goods. Other characteristics are specified in the specification earlier (such as labeling, packaging, transportation, and others).
Such transactions accelerate the process of buying and selling products, and therefore seized a significant market segment in the economic relations between entrepreneurs.
Key features of futures
Futures - what is it? This is not only a type of transaction, but also a set of characteristics that distinguishes them from other types of agreements between partners. So, we can distinguish a number of properties that they possess:
- Futures are characterized by high liquidity, since when concluding they correspond to a set of conditions presented by the exchange.
- Standard and flexible to use - easily sold and disposed of by entering into an agreement on the contrary.
- Risks of a futures contract tend to zero (but not equal to it), since such a transaction is aimed not so much at the actual fact of buying and selling a particular product, but at a price game. For statistics: only the twentieth of the contracts concluded end with real supply, which is associated with the unpredictable behavior of the price curve.
- At the conclusion of the futures, both parties are confident in their partner, because their obligations are insured by the clearing house operating in the framework of the exchange.
- Only those goods are involved in such transactions, the price of which cannot be foreseen for several periods in advance.
What is futures trading for?
A futures contract cannot be considered solely as an instrument of the exchange market, since it performs certain functions in the economic activity of an enterprise.
So, with the process of the evolution of the economy, the relationship between business entities becomes fiercer and riskier. Therefore, futures trading on the stock exchange is a natural process for the survival of an entrepreneur, in which he can not only carry out his operating activities, but also strive to get the maximum profit for it.
From the point of view of economic activity, this type of relationship is a direct way to reduce risks by reinsuring changes in prices for a particular product. Even in such conditions it is possible, albeit illusory, but to predict the level of income in future periods.
Futures should not be confused with forwards
It so happened historically that a futures contract is often confused with a forward contract - either because of the abundance of borrowed words in the exchange terminology, or because of its illiteracy.
A forward is a high-risk deal, since for non-fulfillment of obligations under an agreement, you can get huge amounts of penalties, while the agreements in this article can easily be terminated, as mentioned above.
Moreover, to make a futures contract - because of its nature - is possible only within the bounds of the exchange, but another - on the contrary, beyond its scope. Also, forward contracts are concluded in a transaction for the purchase and sale of absolutely any assets, while futures reinforce relations only in the context of a limited range of goods. And, most importantly, nobody insures forwards, so the risks on them should be considered in a slightly different prism.
Types of futures contracts
For all its narrow focus futures have a wide range of varieties, which are classified according to one or another feature.
For a start it is worth understanding that a futures contract can be commodity and financial. The first is classified depending on the group of assets sold. It can be:
- wood industry products;
- feedstock industry;
- other semi-finished products.
Financial contracts in the context of futures are as follows:
- interest (take place in bond transactions);
- index (goods change value depending on stock market indicators);
- foreign exchange (quotes are made to make money on the dynamics);
- and the last option is the stock one (they are quite rare, the second name is a futures contract on shares).
The main feature of the futures contract
The overwhelming majority of business entities in futures contracts are attracted by the fact that they are standardized (for all types of transactions and in various conditions of implementation). And this means that there are no clearly defined relations between the seller and the buyer in the transaction - there is always an intermediary between them in the face of the clearing house of the exchange.
The price of the futures contract and delivery volumes are the only criteria that differ in such arrangements. This feature cannot be attributed to disadvantages, since it has a number of positive consequences:
- the transaction is quick and painless for both parties;
- the number of contracts is growing;
- mutual settlements are simple, which is a significant attractive feature;
- There are no resource and financial costs for drawing up a template, since a typical contract is concluded.
Futures market today
Buying a futures contract is a complex and rather complicated process, despite the simplicity of its preparation. Three major institutions are involved here.
The first element is the immediate location of the transaction - the exchange itself. It does not carry out any commercial activity and only coordinates the relations between the participants - potential sellers and buyers.
The second element is the clearing house. Without it, it is impossible to conduct any of the transactions, since it is a kind of guarantor and insurer in fulfilling the bilateral obligations of the parties to the agreement.
And the last element is the keeper of the cherished product, around which the vigorous activity on the exchange unfolds. In this role are warehouses.
In order for the above institutions to function, the parties to the contract at the conclusion of the transaction make a certain cash contribution to cover operating expenses.
Futures Market: Transaction Procedure
At the conclusion of the contract the procedure for its execution is divided into three stages. In this case, the final day is the fulfillment of obligations (closing the transaction).
To start the transaction is recorded. On the same day, the necessary contributions from the participants are paid to the treasury, and the fact of the relationship in the clearing house is recorded.
At the second stage, the transaction remains open, the stated amounts of variable costs are paid to the treasury, as well as the missing funds to the initial contributions, if the rates of such have been changed by the clearing house.
At the last stage, the transaction is closed, the profit is calculated and divided, the subject of the agreement (asset) is transferred to the possession of the buyer. If the contract is reset by registration of a reverse agreement, then fees are paid for this service.
Hedging as an element of the futures market
None of the market participants would like to remain at a loss due to the undesirable dynamics of the price of the asset declared in the transaction, so everyone wants to minimize their risks. To this end, hedging with futures contracts is actively used in practice.
However, it is worth noting that this procedure, with an unfavorable price jump, will not bring the desired profit to the participant, but will still be able to protect against losses. It is possible to hedge the transaction process either fully or partially (in this case only certain price ranges are insured).
Both sellers and buyers can minimize risks, but it is worth remembering that the hedge level often depends on the overall financial health of the exchange, since no one has yet canceled speculation in the sale and purchase processes. Therefore, do not forget: the higher the turnover in the market, the more secure your potential profit.