Use a futures contract to make transactions for the sale and purchase of a product or asset in the planned future at a fixed price. This obligation is how the given security differs from an option that gives the right to buy or sell, but is not forced to do so. Futures oblige both parties to the transaction to fulfill their obligations. At the same time, the material exchange of goods during such trading operations is not performed.
- What are futures and why are they used in the investment market?
- Differences between futures and options
- Differences between futures and forward contracts
- Futures trading strategies
- Pros and cons of futures trading
- Types of futures contracts
- Futures contract price – contango and backwardation
- Expiration dates
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What are futures and why are they used in the investment market?
Futures contracts are used to establish the real market price for a particular instrument. They have certain applied value for investors:
- Speculative transactions that allow you to extract material benefits.
- Insurance against risks by hedging , which is interesting for suppliers and buyers of goods.
Futures are used in the commodity and commodity markets, they are characterized by the main parameters:
- The time of execution, namely the date on which the deal is scheduled.
- The subject of the transaction, in particular, raw materials, securities or goods, currency.
- The exchange on which the transaction is made.
- Units of quotation.
- The size of the margin.
A futures contract is a risky, but also an extremely liquid instrument that is not stable. The buyer undertakes to accept the product, which is currently not ready for sale. However, upon the onset of the specified period, no one can oblige him in reality to purchase the goods indicated in the security, since there are no real deliveries here. Futures are needed to fix the price of something, and when they are due, one of three scenarios is possible:
- Maintaining the balance of both parties to the contract.
- Replenishment of balance A and decrease of balance B.
- Replenishment of balance sheet B against the background of reduction of balance sheet A.
If the buyer’s account is replenished against the background of a decrease in the seller’s account, then the value of the instrument increases. That is, investor A could buy the product at a lower price and resell it at a higher price, thus deriving material benefits. In reality, the exchange relieves market participants from carrying out the necessary operations, calculations, immediately giving out the difference in real money to the party to the transaction. If the price has not changed, then the balance remains the same. The third scenario is realized if the price of the product falls, which was initially beneficial to the seller. Now it is possible to sell goods on more favorable terms, the current market price of which is less than the one that was specified in the contact. If we were talking about a real product, then the seller could buy it at market value and sell it at the price specified in the futures. The exchange, in this situation,relieves the parties from the need to transport real goods, but simply makes the necessary calculations and replenishes the seller’s account for a certain amount, which is the difference between the market value and the price specified in the contract. If one of the parties abandons the futures until the moment of its execution, then after the expiration of the terms specified in the contract, a comparison is made between the value specified in the document and the market price of the goods. then after the expiration of the terms prescribed in the contract, a comparison of the cost indicated in the document and the market price of the goods takes place. then after the expiration of the terms prescribed in the contract, a comparison of the cost indicated in the document and the market price of the goods takes place.
How a futures contract works – a practical example of calculation [/ caption] Introduction to a futures contract – a simple lesson for novice investors and traders: https://youtu.be/eTLWgW-_0C0
Differences between futures and options
Futures and options contracts differ among themselves by the obligations of the parties. This manifests itself during the expiration period.
Expiration period [/ caption] In the case of futures, buyers are required to conclude a planned deal, and when buying an option, further actions are at the discretion of the investor. For example, a contract is concluded for the supply of shares, the owner of which wishes to sell them in the future at a certain price. If he finds a buyer, then they conclude a contract, and the seller immediately receives the money, and the delivery will be made at the time of expiration. If we are talking about option contracts, for example, of the call-option type, then the buyer expresses a desire to purchase securities, but at the moment, he does not have the necessary amount for this. The seller agrees, in such a situation, to write an option giving the right to buy shares at the time of expiration. If during this period the buyer does not dare to make a purchase, then the option is simply not executed.However, the seller will be required to sell the securities if the buyer wants to exercise the option, which happens when the market value of the shares changes significantly since the date of the contract. In this case, the deal is executed at the strike price. This difference between options and futures is leveled out if investors are dealing with deliverable contracts. In a situation with settlement contracts, the variation margin is determined daily, and the fundamental difference between options and futures ceases to be felt. In this case, the seller will not be paid the market price upon completion of the transaction. However, the exchange will be able to reserve certain collaterals for the obligations assumed by the parties.when the market value of a share has changed significantly since the date of the contract. In this case, the deal is executed at the strike price. This difference between options and futures is leveled out if investors are dealing with deliverable contracts. In a situation with settlement contracts, the variation margin is determined daily, and the fundamental difference between options and futures ceases to be felt. In this case, the seller will not be paid the market price upon completion of the transaction. However, the exchange will be able to reserve certain collaterals for the obligations assumed by the parties.when the market value of a share has changed significantly since the date of the contract. In this case, the deal is executed at the strike price. This difference between options and futures is leveled out if investors are dealing with deliverable contracts. In a situation with settlement contracts, the variation margin is determined daily, and the fundamental difference between options and futures ceases to be felt. In this case, the seller will not be paid the market price upon completion of the transaction. However, the exchange will be able to reserve certain collaterals for the obligations assumed by the parties.In a situation with settlement contracts, the variation margin is determined daily, and the fundamental difference between options and futures ceases to be felt. In this case, the seller will not be paid the market price upon completion of the transaction. However, the exchange will be able to reserve certain collaterals for the obligations assumed by the parties.In a situation with settlement contracts, the variation margin is determined daily, and the fundamental difference between options and futures ceases to be felt. In this case, the seller will not be paid the market price upon completion of the transaction. However, the exchange will be able to reserve certain collaterals for the obligations assumed by the parties.
Clearing is carried out on a daily basis, within the framework of which there are mutual payments of the variation margin up to expiration. In such a situation, it becomes economically impractical to exercise the option, since it is impossible to deliver the asset at the cost that was relevant at the time of the contract. With this development of events, there is always a time premium in the option value, which is lost with the onset of expiration. The option exercise will not affect the account balance, and the terminal will replace the option with a futures. Futures expiration – what happens to the position: https://youtu.be/QQjRRxXZP3Y
Differences between futures and forward contracts
Also, there are differences between forward and futures contracts, which are entered into by investors. A forward is called one-time transactions made outside the exchanges and assuming that the purchase of goods, securities or currency will occur in the future time. The parties discuss the main conditions in advance:
- additional conditions.
In this case, the transaction is carried out with real assets, and not as with futures, when the transfer of goods is not involved.
The forward is intended to insure the participants in the transaction against price fluctuations that are likely to occur in the future. There are no strict standards when concluding a contract, so such transactions cannot be carried out on the exchange.
Forward and futures contract [/ caption] Forward and futures contracts differ from each other in the following aspects:
- goals – the forward will be concluded for the sale or purchase of real assets, which implies the consideration of all conditions favorable to both parties. In the second case, futures contracts are hedging their own positions or taking advantage of the price difference. Futures only in 5% of cases lead the parties to the exchange of real goods or financial instruments;
- asset volume – when concluding a forward contract, the parties to the transaction independently calculate the required volume, taking into account their needs. In the case of futures, the volumes are determined by the exchange, and market participants have the right to sell a certain number of contracts;
- quality of instruments – a forward provides an opportunity to use assets of any quality, depending on how requests come from the buyer. When it comes to futures, the quality of the instruments is determined by the specification of the exchange;
- delivery of goods – when signing a forward, assets are always delivered, and when a futures is concluded, delivery is carried out in the form established by the exchange, but in most cases it does not reach this at all;
- terms – the terms of delivery when signing the forward are determined by the parties to the transaction. The terms of futures contracts are determined by the exchange;
- liquidity – a forward contract is characterized by limited liquidity, since the conditions for its conclusion are acceptable for a certain range of counterparties, between whom it was concluded. Futures are highly liquid instruments, however, the level of this indicator depends on the quality of the underlying asset.
futures and options [/ caption] The risk of a transaction when signing a forward is quite high, since there is a likelihood that the partner will not fulfill its obligations. It is extremely difficult to resell such a contract, because its terms were drawn up taking into account the preferences of a narrow circle of people. The forward cannot be canceled if the counterparty does not give its consent to this. As for the risks associated with futures, they are analyzed in detail by the clearing house before entering into a transaction, due to which the derivatives are characterized by a high degree of reliability. The use of a forward is not associated with the payment of down payments as a guarantee. As for futures, in this case, it is extremely rare to do without them. The procedure for concluding a transaction when drawing up a forward contract is not regulated by anyone,but futures are fully controlled by the exchange.
Futures trading strategies
To trade futures, traders use several popular techniques:
- the comparison of the exchange schedule of the contract with the next month for which the delivery is planned and the reporting period following it is carried out ;
- a comparison of the spot price for a share and a futures is carried out , if its value is higher, then we are talking about contango , which is considered a premium relative to the price of an asset. If the situation is reversed in the market, then it is called backwardation , which is considered a discount in relation to the base cost. It is on the exchange rate difference that arises in this situation that traders earn;
- studying the futures schedule using technical analysis, indicators, fundamental factors that can affect the price of the contract.
Trading by support levels:
The “Arbitrage” trading strategy involves the execution of transactions with different directions. This allows you to profit from the difference between the buy and sell price. The procedure is carried out on different exchanges or on the same site. Sometimes the technique of temporary arbitration is used, when contracts are drawn up on the same exchange, but in different periods. There are the following types of “Arbitration”:
Earnings without trends and indicators: futures arbitrage [/ caption] When trading futures contracts, traders can open short and long positions. This technique assumes the purchase of a contract for the supply of a certain asset and, in the event of an increase in the value of a futures, implements it even before the expiration of the contract. Working with short positions is to sell the futures in case of unfavorable development of events. If the situation is corrected later, then he buys the contract back, but at a lower cost, earning on the difference in price. Futures will move in sync with the underlying asset, but there is some difference between them, which levels out as expiration approaches. Opening a position in a futures contract [/ caption] A futures spread is the simultaneous opening of short and long positions, for example, buying and selling the same underlying asset. They will differ in expiration dates. If a trader enters a long position, then we are talking about a bullish spread. Short positions are used in a bear market for short-term contracts. If the strategy is used in relation to various assets, then we are talking about the inter-commodity spread.
Futures trading using the inter-exchange spread strategy [/ caption] What are futures and how to trade on the derivatives market of the Moscow Exchange – trading strategies for futures contracts: https: / /youtu.be/ZDg14Rya6LI
Pros and cons of futures trading
There are several advantages of futures trading:
- there are no additional costs and hidden commissions;
- there is access to a pool of futures with expiration for a year;
- high asset liquidity, volatility and dynamic trading.
Disadvantages of trading futures contracts:
- not suitable for long-term trading, as it is valid for a certain time;
- when expiration occurs, transactions are closed automatically, taking into account the current market price and deleting pending orders;
- you cannot transfer open trades to a contract expiring next month.
Weigh the pros and cons before trading these highly risky instruments.
Types of futures contracts
There are two types of futures contracts:
- Settlement – without supplies.
Deliverable futures oblige the buyer and the seller to make the actual sale of the goods and pay for it within the terms specified in the contract. The settlement between them is carried out at the price that was fixed on the last day of trading. If with the onset of the due date the seller was unable to provide the buyer with the goods, then the exchange imposes penalties on him.
Estimatedfutures have nothing to do with actual deliveries of products. It is assumed that one of the parties will pay the second party to the transaction the difference between the value of the asset during the period of the transaction and the actual price of the product at the time of the expiration of the contract. Settlement between counterparties is made in cash, and physical delivery of goods is not provided. Such transactions are made for hedging or speculative manipulation. Hedging allows you to level out the probable losses incurred when entering into a contract in another market.
Futures contract price – contango and backwardation
A futures contract is categorized as an individual commodity with a value that differs from the price of the asset. This indicator may be influenced by forecasts and risks caused by a likely change in the subject matter of previously reached agreements. The price of an asset in the market and the value of a futures for this commodity can have a negative or positive ratio.
If a contract is more expensive than an asset, then this condition is called contango. In the case when the situation is the opposite, we are talking about backwardation.
In this situation, most investors hope that the price of the asset on the stock exchanges will soon significantly decrease.
Contango and backwardation on the chart [/ caption] The price of a futures is the current market value of a contract that has a specific expiration date. Fair price is defined as the cost to acquire an asset that will be immediately delivered and held thereafter until it is used, profited, sold or used. At the same time, at a fair price, it is profitable for a trader to purchase a contract for an asset with a specific expiration date. The difference between the corresponding and the current price is called the basis of the contract, which is the relative spot value of the asset in two states.
What affects the value of a futures contract [/ caption]
Trading is carried out on condition that the transaction is secured by means of a deposit, the size of which is 2 – 10% of the price of the contract asset. This is the insurance required by the exchange from both contracting parties. The set amount is blocked on the accounts, forming a kind of collateral. If the price of a futures rises, then the seller’s collateral increases, and if it decreases, it decreases. This mechanism avoids the payment procedure when concluding a contract. When a futures is held until it closes, the parties fulfill their obligations by supplying assets or transferring funds. When one of the participants does not want to fulfill their obligations, the exchange does it for him, leaving himself a certain amount of the guarantee. This scheme only works for contracts that provide for the delivery of an asset.
There are several contract expiration dates. For example, for a dollar index, stocks, financial instruments, the expiration date is quarterly on the third Friday of the last month of the quarter. There are futures with a monthly output, in particular CME Crude Oil. Other types of contracts may end on other days. To trade futures productively, remember the expiration date of the contract. If there is an unexpected decrease in volume after the expiration of the next day of trading, then the deadlines are approaching, and most of the traders begin to close deals before the termination of the contract.
Structure of a futures contract [/ caption] Each futures contract has an expiration date. Check the contract specifications for the expiration dates of your contract. There is usually a significant drop in volume as the futures contract arrives within days of its expiration. This is because all short-term traders close their positions and only people and companies that want to buy or sell the underlying product continue to trade and hold their positions until expiration. Short-term traders do not enter futures contracts before expiration, they simply make or lose money based on price fluctuations that occur after buying or shortening the contract.
- 1 What are futures and why are they used in the investment market?
- 2 Differences between futures and options
- 3 Differences between futures and forward contracts
- 4 Futures trading strategies
- 5 Pros and cons of futures trading
- 6 Types of futures contracts