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March 29, 2018

Question:What is Futures contract? How does it work?

Answer:

A futures contract is an agreement between two parties to buy or sell a specified asset in the future for a price agreed upon today.

Futures contract help mitigate the risk of world price fluctuations of the asset.

The party agreeing to buy the underlying asset in the future is said to be “Long” and a party agreeing to sell the asset in the future it said to be “Short”.

In every futures contract, everything is specified:

  1. The quantity and quality of the asset
  2. The specific price per unit
  3. The Date and method of delivery

The price of a futures contract is represented by the agreed-upon price of the underlying commodity or financial instruments that will be delivered in the future.

But although the future’s contract has an expiration date, you don’t have to hold the contract until it expires you can cancel it anytime you like.

Participating in the future’s market does not necessarily mean that you’ll be responsible for receiving or delivering large inventories of physical commodities.

Remember, buyers and sellers in the future’s market, primarily enter into futures contracts to hedge risk or speculate rather than to exchange physical goods.

That is why futures a used as financial instruments by not only producers and consumers but also speculators.

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