Futures – Meaning, features, hedge by futures and example
NOTES BY SACHIN ARORA
Meaning of Futures:
Futures are standardized financial contracts that obligate the buyer to purchase, and the seller to sell, an asset (like commodities, currencies, or financial instruments) at a predetermined price on a specified future date. These contracts are traded on organized exchanges and are used for both hedging and speculation purposes.
Features of Futures Contracts:
- Standardized Contracts: Futures contracts are standardized in terms of quantity, quality, price, and delivery date. This standardization ensures uniformity and makes trading easier on exchanges.
- Traded on Exchanges: Futures are traded on organized and regulated exchanges like NSE (National Stock Exchange) or MCX (Multi Commodity Exchange) in India. This ensures transparency and reduces counterparty risk.
NOTES BY SACHIN ARORA
- Margin Requirement: Traders need to deposit an initial margin to enter a futures position. Margins act as a security and are adjusted daily based on market movements (known as Mark-to-Market settlement).
- Obligation to Buy or Sell: Unlike options, futures create a legal obligation for the buyer to buy and the seller to sell the asset at the agreed date and price, irrespective of the market price on the maturity date.
- Future Delivery Date: Every futures contract specifies a future date on which the transaction will take place. However, most contracts are squared off before the expiry rather than actual delivery taking place.
- Hedging and Speculation: Futures are used by hedgers to protect against price fluctuations (e.g., farmers, exporters), and by speculators to earn profits from price changes without owning the actual asset.
NOTES BY SACHIN ARORA
What is Hedging?
Hedging is a risk management strategy used to protect against the possibility of future price fluctuations in an asset. The aim is not to make a profit, but to minimize potential losses.
