Futures, or futures contracts are units of trading at a commodity exchange. They are legally binding agreements between two parties to buy or sell at a specific time in the future for a specific time in the future for a specific price determined today. These agreements are standardized according to quality, quantity, delivery time and location.
The basic function of a futures market is to offer hedging opportunity to the commercial sector as an efficient means for managing or eliminating price risk.
Another function is to provide Price Discovery to make prices public and widely available.
All futures markets respond to the basic forces of supply and demand either through the broad influences of factors applying to a particular commodity or financial instrument. Usually a combination of forces exists at any one time to move prices up or down. It should be noted that technical market factors apart from fundamental influences can also affect price movements. Examination of historical price patterns is frequently translated into current market strategy.
Yes; by the Government as well as the respective Exchanges. The Exchange closely monitors trading activities and the financial health of Member companies. In addition to this self-regulating process an independent regulatory agency is normally set up to oversee futures markets and trading activities.
The Exchange, through its Clearing House is the guarantor of futures contracts. Each business day, the Clearing Members submit trade records. After they have been verified, the Clearing House becomes the opposite part to every transaction. In effect, it becomes the buyer for every seller and the seller for every buyer. Traders therefore need never worry about who was originally on the other side of the transaction.
Traders in futures market include the commercial participant, or hedger for whom futures markets were designed for them to hedge their risk against unfavorable price changes and the speculator who seek to profit from anticipated increases or decreases in prices.
Hedgers are the firms or individuals who produce or need the commodities being traded in the futures market. They represent a broad cross-section of international industries, including Agricultural Commodities Products and Forest Products, Precious and other Non-ferrous Metals, Energy, and Money Market Instruments.
Hedging is a form of low cost forward pricing used by business and individuals to gain financial protection and maintain profitability. Because the price of futures contract tends to converge with the cash price when the time period of the contract expires, hedging offers valuable price protection for both processors and producers. Hedging allows both processors and producers to make marketing decisions with the knowledge that they are protected against unfavorable price changes. As a result, they are able to market their products more efficiently and with greater expectation of consistent profits.
Beside using the market to establish a selling price or buying price strategies, hedgers can increase financial leverage (many banks will make larger loans to businesses hedged by futures). The futures 'price discovery' feature is also valuable in making marketing decisions.
Speculators, through the pursuit of profits, help create liquid markets. Only those markets used actively by a broad range of trading interests, including large and small speculators, are suitable for commercial hedgers seeking to transfer their risk. Constant trading creates liquid markets that allow easy access to buy and sell futures contracts.
An opportunity for profit and leverage. Since futures positions are taken on a low margin, the trader’s gains and losses are magnified. With the margin deposit for a futures contract often less than five percent of face value, just a small change in price can result in considerable gains or losses relative to the initial deposit. Futures require monitoring on a daily or even hourly basis, because the impact of even a small price fluctuation on a trader’s account can be great. A well-organized trading plan, and the discipline to follow it, is the key to successful futures trading.