Introduction to Futures Contracts: There are many different elements underlying futures contracts that is essential to understand if we want to dig further into the topic and enhance our understanding. We therefore offer a short introduction to futures contracts and elements related thereto.
What is a futures contract?
A futures contract is simply a requirement to have or obtain a specific quantity of something at future dates. It is a financial instrument that specifies the quantity, delivery date and price in advance. These three elements are well understood and fixed until maturity of the contract.
A futures contract may involve a variety of elements, such as natural goods (like oil) or financial instruments. In a futures contract relationship, the seller has the obligation to respect the contract and deliver the goods described therein. The buyer, in turn, will necessarily take possession of the property when the contract comes to term.
One of the important features of futures contract is that the seller and the buyer must deposit an amount (often called margin requirement) when conducting a transaction. The margin is often calculated as a percentage of the fair value of the futures contract. It is understood that this margin requirement must be met every day.
As gains or losses on futures contracts are calculated on a daily basis, it is possible for the buyer (if the value decreases) have the obligation to make an additional deposit to meet the margin. The principle also works the other way, in fact if the contract value increases, it is the seller who must file an additional sum to meet the minimum margin.
The Market Players in Futures Contracts
1 – Speculators
The first major player in the futures market is the speculator. As its name suggests, it speculates on the value of property related to futures and thus assumes the risk related to changes in value. Its aim is to realize a gain on the futures contract. The speculator can for example use a short position or a long position to achieve his ends.
Unlike speculators, hedgers main objective of is to use a futures contract to hedge against a possible volatility of a futures contract. It is understood that the hedgers are often producers or direct users of the hedged item.