A futures contract is an agreement to buy or sell an underlying financial asset or commodity at a predetermined price and date. Each futures contract represents an amount of a given commodity or financial instrument.
More about Futures Contracts
Some futures contracts call for the physical delivery of the asset, while others are settled with money. For investors, futures contracts are very useful to hedge away from risks and speculate, instead of actually exchanging commodities.
The futures market is a key financial exchange that supports intense competition between buyers and sellers, also providing a center to manage price risks. it’s a very liquid market that consists of some of the most actively traded instruments in the world.
For instance, the e-mini S&P 500 is a stock index futures contract that has an average daily trading volume of more than 1.6 million contracts.
Riskier Venture
The futures market is considered to be generally riskier than buying and selling stocks. This is mainly because of the leverage involved.
Yet, futures are still a very in-demand trading instrument for several market participants, which range from small-time retail traders to high frequency traders.
Participants in the futures market includes:
Hedgers
Hedgers can be farmers, manufacturers, importers, and exporters. A hedger buys or sells in the futures market to secure future price of a commodity intended to be sold later in the cash market.
This helps protect prices against potential risks, so you can think of it as somewhat similar to an insurance policy.
If you go long in a futures contract, you are trying to secure as low a price as possible. Conversely, if you short sell a contract, you want as high a price as possible, similar with short selling a stock.
On the other hand, the futures contract offers a definite price certainty for both parties, which minimizes the risks associated with price volatility.
Hedging by using a futures contract can also be great to lock in a reasonable price margin between the costs of the raw materials and the retail cost of the final product that has been sold.
Speculators
Others don’t aim to minimize their risks. They rather try to benefit from the naturally risky nature of the futures market. These are called the speculators, and they try to profit from the very price changes that hedgers are trying to get away from.
Speculators want to increase their risk and thus maximize the potential profits. Unlike hedgers, they don’t want to own the underlying commodity. Instead, they enter the market to profit from increasing and falling prices.
Regulatory Bodies
The US futures market is regulated by the Commodity Futures Trading Commission (CFTC), which is an independent agency of the US government established by the Commodity Futures Trading Commission Act.
The futures market is also under the regulation of the National Trading Association, which is a self-regulatory organization authorized by the US Congress and subject to CFTC supervision.
Futures brokers must be registered with the NFA and the CFTC to conduct business.
