What is a futures contract?


What is a futures contract? The article summarizes all information about futures contracts: Benefits, characteristics, futures derivatives trading strategies for investors,…

Benefits of futures Futures FeaturesEffective Futures Derivative Investment Strategies

What is a futures contract?

In the financial sector, futures contract (futures contract) is a standardized contract between two parties for the exchange of a specific asset of standardized quality and volume for today’s agreed price (called a futures contract). futures price (futures price) or origination price) but deliver the goods at a specified time in the future, delivery date). These contracts are traded through the futures exchange. One party agrees to buy the underlying asset in the future, or the “buyer” in the contract, called the “long”, and the other agrees to sell in the future, or the “sell” in the contract. , called “short”. The above term reflects the expectations of the parties – the seller expects the price of the good to fall, and the buyer expects the price of the commodity to rise. Note that the contract itself is free of charge to sign; the term buy/sell is just a convenient linguistic tool to reflect the positions of the parties (long or short).

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In many cases, the underlying asset in a futures contract may not be a traditional “commodity” at all – that is, in a financial futures contract, the underlying asset or commodity may be currencies, securities or financial instruments and intangible assets or referenced items such as stock indices and interest rates.

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Futures contract

Example of a futures contract

A futures contract is an agreement between two parties, a buyer and a seller, for a transaction to take place in the future at a price determined from the time the contract is signed.

For example: Company A signs a futures contract to sell company B 100,000 barrels of oil in May 2018 at the price of VND 1,500,000/barrel. By September 2018, if the oil price increases by 2,000,000 VND/barrel, there will be two options for company A as follows: Either A will deliver to B 100,000 barrels of oil at the price of 1,500,000 VND/barrel or Company A will not sell oil to company B but will pay the difference according to the original agreement to company B in the amount: 500,000×100,000 = VND 50,000,000,000

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Commodity derivatives trading

Futures contract concepts

Concept Explain
Futures contract An agreement between a buyer and a seller for a future transaction at a predetermined price.
Base asset Is the subject matter agreed in the derivative contract.
Escrow The deposit to participate in derivatives trading, plays the role of ensuring the solvency of the two contracting parties.
Position The trading status and volume of the derivative contract that the investor is currently holding.
Close position Open a counter position with an existing position with the same underlying asset and expiration date.
Payment price at the end of the day The price of the derivative contract is used to calculate the value of profit/loss arising in the day of each contract.
Final payment price The price of the underlying asset is determined on the last trading day of the derivative based on that underlying asset, used to calculate the value of profit/loss arising on the last trading day of the contract. .
Contract Multiplier The coefficient to convert the value of the Index Futures into money.
Open volume Number of contracts of a type of Derivative Securities in existence at a time.
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Benefits of futures contract

Easy and convenient futures contract trading

Trading futures contracts Similar to stock trading. Investors who predict a rising market will place buy orders to open long positions in futures contracts, when the market rises as expected, investors will get profits. Conversely, investors can open a short position in futures contracts to make a profit in a down market.

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Benefit from high leverage ratio

With the characteristics of only needing to deposit a part of the contract value, the futures contract will bring investors a very high level of leverage, making the profit received can be much larger than investing in stocks. However, high leverage can also bring great losses if the market goes against the investor’s prediction, so investors need to keep a close eye on the market when holding a futures contract.

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Can buy/sell continuously during the day

If in stock trading, after buying shares, investors have to wait 2 days for stocks to return to their account before they can sell, then in futures contract trading, the benefits from investors having You can immediately close an opened position (whether long or short). Thus, investors can continuously open and close positions during the session to seek profits on all market fluctuations.

Opportunity to earn profit when the market drops

Currently, in the stock market, investors do not have the tools to find profits in the falling market. However, with futures contracts, investors can completely do this. An investor can enter into a short position in a futures contract at any time with the only condition that it must satisfy the required amount of margin before entering the contract. When the index falls as expected, the investor gets a profit from his futures sale.

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Opportunity to earn profit when the market drops

Features of futures contract

In order to understand the futures contract – an instrument of derivative securities, investors must know the Features of futures contractthereby helping investors have many advantages when participating in the derivatives market better.

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Normalization

A futures contract is an instrument listed and traded on a derivatives exchange. Therefore, the futures contract features that the terms of the contract are standardized.

Specifically, the exchange where the futures contract is listed will specify the details of a contract, such as: the type and quality of the underlying asset, the size of the contract (the amount of the underlying asset). exchange corresponding to a contract), the method of delivery – receipt as well as payment between the two parties when the contract expires…

Listed

Listed and standardized on the Derivatives Exchange, so the futures contract is standardized in terms of terms, value, volume of the underlying asset, etc.

Clearing and Margin

In the futures market, margin is a measure to secure the performance of a contractual obligation for both the buyer and the seller when the contract is settled. Investors participating in this market must meet the margin requirements specified by the exchange and clearinghouse for each type of futures contract.

Futures contracts require the parties to make a deposit to:

Make sure the payment is mandatory.Payment and clearing at the actual price daily and will notify the profit and loss into the investor’s margin account according to the actual price and call for additional margin when needed. Thus reducing the risk of insolvency of the parties involved.Easy to close position

Investors participating in futures contracts can close their positions at any time by taking a reverse position on similar futures contracts. Thereby, helping futures contract users to be flexible in using capital.

Financial leverage

When participating in the futures market, investors have the ability to make impressive profits with only a very small initial investment amount (compared to investing in the underlying asset market). .

An investor who wants to buy or sell a futures contract only needs to meet the margin requirement, which is a financial commitment to secure the contract’s performance.

When an investor’s prediction about the price movement of the underlying asset comes true, the investor earns a profit from the futures position he holds. Due to the leverage effect of the margin, the return on this market is often much higher than the return on the underlying asset market.

Commitment to the performance of future obligations

When trading futures contracts, both parties holding the long and short positions of the contract are bound by certain rights and obligations.

Specifically, at the maturity of a futures contract, the seller is obliged to deliver a determined amount of the underlying asset to the buyer and has the right to receive money from the buyer, while the buyer is obliged to pay as agreed in the futures contract and receive payment. property transferred from the seller.

Creditial

Based on the terms of the contract, investors participating in the futures futures trading market know clearly in advance what they can (or will) buy and sell, how to trade at any time in the future. future.

Therefore, investors can open and close positions as needed easily. This makes the futures market very liquid, and makes futures a convenient instrument for investors to use for a variety of purposes.

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How do futures contracts work?

Mechanism futures contract trading almost similar to common stock. The attractiveness of the futures product is reflected in the fact that investors can buy/sell without holding the corresponding underlying asset. The nature of futures contracts is to trade based on investors’ price expectations. Therefore, when believing that the market will fall, investors can completely short sell futures contracts to protect their portfolio first and then buy them back to take profits/losses. When hedging with futures contracts, the decrease – increase in portfolio value will be offset by the increase and decrease of the futures contract.

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Photo: Futures contract trading mechanism

*In this process, a trading member is also a clearing member

Effective futures derivatives investment strategies

Speculative trading strategy following the price trend

This is the most used strategy because of its simplicity and attractiveness but also comes with higher risks than other strategies. Accordingly, if investors forecast that the market will increase in price, they will buy futures contracts and wait to sell to close the position when the price increases.

In the opposite direction, investors will sell the futures contract when predicting that the market will drop and make a Buy position to close the trading position.

Day trading strategy

Day trading is narrowly understood as investors buying and selling during the day; At the end of the day, investors close all positions bringing their holdings to zero, thereby not subject to overnight price movements. In a broader sense, the above trade can account for positions held overnight to a few days.

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Investors can visit dautuhanghoa for more information on Commodity Trading, How to invest in commodity derivatives effectively?. Or leave information so that Zhuge Liang can guide and support you to learn more about this market.

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