Different types of futures contracts

Futures contracts and types

Different types of futures contracts

A futures contract is a right and an obligation to buy or to sell an asset. Remember when we talk of types of futures contracts, there are futures across asset classes. The different types of futures contracts include equity futures, index futures, commodity futures, currency futures, interest rate futures, vix futures, etc. The concept across all the types of futures is the same. They are all a contract between a buyer and seller for delivery at a future date

Different types of futures contracts
Let us take a quick look at the different types of futures contracts available in india. Remember, these futures options are different from options because an option is a right to the buyer without an obligation; and an obligation to the seller without the right. For now, let us stick to futures.
Equity stock futures: if you expect reliance to go up and want to buy 1000 shares but don’t have the money, then what do you do? You can buy reliance futures. Similarly, if you expect the reliance price to go down, you can also sell the reliance futures. Either way, you make profits if the price movement is in your favor, otherwise, you make a loss. Equity futures in the organized format is less than 20 years old in india. Equity futures give you leverage. You deposit an initial margin like say 20% with the broker and you can trade 5 times the money you have. Futures are only available on a selected list of stocks.
Equity index futures: if you don’t want to take the risk of stocks, you can buy or sell index futures. In india, the nifty futures and the bank nifty futures are not only popular but also extremely liquid. Index futures can be used to speculate on the movements of broad-based indices with lower risk than stock futures. Index futures can be used for hedging and arbitrage but we will not get into all that now.
Currency futures: this organized currency futures market came into india in 2008 and has become extremely popular. You can bet on currencies and protect your currency payment or receipt risk. For example, if you expect the dollar to strengthen, you buy usdinr futures and if you expect the rupee to strengthen then you sell usdinr futures. You can trade futures on dollars, pounds, euros, and yen.
Commodity futures: have been very popular but ctt has taken some sheen off commodity futures. Like the other futures, commodity futures also allow hedging against price changes in the various commodities including agricultural products, precious metals like gold and silver, hydrocarbons like oil and natural gas as well as industrial metals like aluminum, zinc, nickel, and copper. Initial margins are low in commodities so it attracts a lot of speculators. Commodity futures happen principally in mcx and ncdex in india.
Interest rate futures: interest rate futures represent a contract to buy or sell government security or t-bill at a specified price on a predetermined date. The interest yield is implied in the bond prices and you can bet on rates rising or rates falling and also hedge your interest rate risk.
Vix futures: the vix is the volatility index and you can bet on whether market volatility will go up or go down. It has nothing to do with the market direction. Vix is called the fear index and is a barometer of investor panic. Normally sharp market corrections are accompanied by a spurt in vix.
What are futures?
As the name suggests, the future is a contract that pertains to the future. In finance parlance, futures are a contract that is legal and standardized. It is an agreement to buy or sell an underlying asset at a predetermined price at a specified time in the future. Normally, this deal is between two parties not known to each other. Futures are different from forwards in the sense that forwards are customized otc products but futures are standardized exchange-traded products. On nse and bse, all futures contracts have the counter-guarantee of the clearing corporation.
What are derivatives?
In the world of finance, a derivative is a contract that derives its value from the performance of an underlying asset. In short, that is how the word derivative comes as it derives value from an underlying. This underlying can be an asset, index, or interest rate, and is often simply called the "underlying".
Derivatives contracts are typical of four categories viz. Forwards, futures, options, and swaps. These four products combined are called derivatives.
A futures contract is a legally binding contract that creates an obligation for the concerned parties to trade into an asset at a price, and on a pre-decided date. The market price of the asset at the time of expiry of the contract is not of concern in such contracts. The parties to the contract have to settle the trade compulsorily at the price set while entering into the contract. Futures contracts are standardized in nature, mentioning the price, quality, and quantity in advance so that traders can trade in them seamlessly on a futures exchange. There are many types of futures contracts that we categorize depending upon their underlying asset. The most common types of futures contracts are commodities futures, stocks and bonds futures, currency futures, interest rates futures.
The first category is of those people who use it as a tool for hedging their risk of unfavorable price movement of an asset in the future. They enter into the futures contract to fix a price for their trade. This minimizes any uncertainty as well as the risk of prices going up or down in the future.
The second category is those of speculators. They have no intention of taking the physical delivery of the asset. They look for making quick profits at the expiry of the contract by differences in the price of the asset at that date.
Futures contracts may seem similar to options as both can be settled in near future. But there is a major difference between the two. Options just give a right to trade in the asset at the time of expiry of the contract or even before. They do not create an obligation to do the same. But futures contracts create an obligation to settle the contract at the expiry of the time period.
Commodities are tangible assets that investors can physically buy and sell. The most common commodities in which investors buy futures contracts are oil, metals, natural gas, food grains, etc. The security behind such contracts is the assets themselves.
Commodities futures are very important for the management of price risk, especially to people like farmers. The primary producer of crops or the farmer can enter into a futures contract to sell his produce at a particular price at a particular date in the future. This way, he gets an assurance of the price he will get for his efforts. He can be free from the tension of losses because of the price going down in the future. Similarly, the purchaser of food grains from the farmer will also know in advance the price which he has to pay for the food grains. He can accordingly plan his production if the product is a raw material for his further production. Or he may sell the produce at a higher rate and ensure that he makes a profit from the trade. Oil and gold are other important commodities in which futures contracts play a major role globally.
Currency futures are contracts on the exchange price of currencies. The parties to the contract fix an exchange rate for the exchange of two currencies on a specific date in the future. Such contracts help to nullify the exchange rate risk that may arise in the case of international trade over a period of time. Usually, the parties close these contracts before the date of expiry as per their need.
For example, suppose Mr.X has an investment in India which is due to mature in November this year. One USD is equal to 75 INR at the current exchange rate. He can buy currency futures and lock the current exchange rate of USD to INR. Thus, he will be sure of what investment amount he will receive at this currency exchange rate, no matter what the currency exchange rate is at that time
Interest rate futures are a sort of hedging against the risk that may arise due to fluctuations in the rate of interest of a financial instrument at a future date. Uncertain interest rates may create an extra interest burden on companies and result in heavy losses. We usually use interest rates futures with a money market or bond market instruments such as government bonds, bills, etc. They are the underlying assets for such futures contracts.
Whenever there is a rise in the rate of interest, the prices of the bonds fall. Similarly, bond prices rise with a fall in the rate of interest. An investor can sell interest rates futures contract when the interest rates rise and the price of his bonds fall. They can then repurchase the bonds at a lower rate from the market. This will help them to offset some of the losses they will suffer by a fall in the price of the bonds.
Investors use single stock and stock market index futures as a tool for hedging against risks, speculations, or simply for trading. They are also an indicator of the confidence and sentiments of investors in the market. Single stock futures are a hedge against the future price of the stock. While stock market index futures track the movements of an index.
Stock futures are derivative financial contracts that create an obligation to buy or sell a stock at a specific price and date in the future. They are useful for investors who have a considerable investment in one or few stocks. They want to cover their risk position in case of an adverse stock price movement in the future.
Similarly, stock market index futures create an obligation to trade on the basis of an underlying index and its movements. They are not deliverable at the expiry of their term. Investors just settle their position on such futures in cash. They also help investors to take positions on indexes specified and hedge their risks. People use these contracts for speculative purposes as well to make quick profits as there is no physical delivery and only cash settlement.
Commodities futures are very important for the management of price risk, especially to people like farmers. The primary producer of crops or the farmer can enter into a futures contract to sell his produce at a particular price at a particular date in the future. This way, he gets an assurance of the price he will get for his efforts. He can be free from the tension of losses because of the price going down in the future.
Futures contracts are exchange-traded derivatives traded in a centralized intermediary, for example, the National Stock Exchange of India (NSE). As a contract, it has similarities with another derivative contract – the forward contract. In both cases, counterparties agree to trade a security or an asset at a pre-decided price in the future. However, the significant difference with a forward contract is that a futures contract is standardized in terms of lot size or contract size, expiry date, thus allowing less room for personalization. The exchange on which the contract is tradable determines and regulates its conditions.
Additional read: What is the difference between a forward and a future contract?
Which market participants use futures contracts?
Hedgers: They use this type of contract to protect themselves from the future price rise. The goal here is to prevent losses rather than to bet on the price movement of an asset. Here, the buyer and the seller would lock the price of an asset and honour the contract. That would be regardless of the price at a future date. If the price decreases, the seller would profit on the hedge that would balance out the losses of selling that asset in an open market.
Speculators: They use this type of contract to predict and profit on the price movement of an asset. They are positioned for a profit if the price is directed towards a higher price at expiration than the original contract price. If it's the other way around, they may choose an offsetting position to eliminate risks and losses associated with the original contract. Here, the contract is cash-settled instead of the physical delivery of the asset from the seller to the buyer.
Types of futures contracts:
While the derivatives market commonly associate futures with commodities like corn, wheat, crude oil, etc., futures are traded for other kinds of assets, too, like:
Stock index futures: A contract where the underlying asset is a specified quality of an individual stock. For example, S&P 500.
Currency futures: A contract where the underlying currency is a specified quantity of that currency. For example, euro or dollar.
Interest rate futures: A contract where the underlying currency is a specified quantity of an interest-bearing asset. For example, treasury bills or treasury bonds.
Precious metal futures: A contract where the underlying currency is a specified quantity of gold or silver or any other precious metal.
Additional read: What are Currency Futures?
Pros of Future Contracts:
Hedging: Because future contracts allow risk tolerance and protection from price volatility, they ensure access and flow of capital to all investors
Low margin: Investors have to uphold only 5% - 10% of the contract value
No time decay: Futures markets usually trade in asset classes whose value do not depreciate over time, like gold.
Low counterparty risk: Unlike a forward contract, a clearing house's standardization and regulation of a futures contract make it less prone to a credit default.
High liquidity: Futures markets trade in assets that can most readily be converted into cash.
Cons of Futures Contracts:
Leverage: Because futures contracts offer a shallow margin, investors can lose money much more quickly if the price movement is not in the right direction.
Less control over future pitfalls: Future contracts offer little room to predict and control future damage like currency downfall due to politics.
Fixed expiration dates: Asset value may look less attractive as the expiration date approaches. But being regulated, that date should remain unchanged.
Conclusion:
Future contracts are an attractive instrument to gain access to the capital market with little upfront costs. Being regulated allows less room for counterparty risks. However, investors need to tread cautiously and follow the market closely to gain maximum profit with minimal margin.
Futures traders can approach futures contracts in two ways: hedging and speculating.
Hedgers: Hedgers use futures contracts to protect themselves from the price movement of an underlying asset. By making a futures contract, the hedger essentially guarantees the current market price to avoid a harmful loss if the asset price changes adversely. For example, there are constant fluctuations in oil pricing, and an oil company might enter into an oil futures contract with a buyer if they think the present-day market price of oil is higher than when their buyer would want to purchase the oil in the future. Conversely, an oil buyer worried the price of oil would rise in the future may try to lock the current oil price in with a futures contract, so they don't need to worry about negative market volatility.
Speculators: Speculators use futures contracts to bet on the futures price of an asset to profit by taking either a long position or short position. For example, a speculator who believes that the current price of gold will skyrocket might purchase gold futures at the low market price, then sell the contracts back at a higher contract price to turn a profit. Or if the speculator thinks the price of gold is inflated, they could short sell gold futures, wait until the price of gold decreases, and purchase the futures contracts back at the lower price. Speculators make educated guesses; speculating is a short-term trading strategy that's high-risk
Investors trade futures on public futures exchanges such as the New York Mercantile Exchange (NYMEX), the Chicago Mercantile Exchange (CME), and the Chicago Board of Trade (CBOT). These exchanges are part of the CME Group, which is the world's biggest financial derivatives exchange. Like a stock market exchange, the purpose of a futures exchange is to provide a structured and regulated location to conduct trades.
Most futures trades involve commodities—like oil, precious metals, or crops—but you can also trade currency, ETFs, bonds, stocks, mutual funds, and index futures on the futures exchange. The exchange has a clearinghouse that acts as the middleman for every trade on the exchange, assuming all credit risk and guaranteeing future contracts. An independent US government agency called the Commodity Futures Trading Commission (CFTC) regulates trading on all futures exchanges to prevent fraudulent futures market pricing.
Futures vs. Forward Contract: What’s the Difference?
A futures contract and a forward contract are both derivative contracts that agree to trade an asset between two counterparties at a specific price by a designated future date. Still, there are some critical differences between both investment types:
Contract terms: Futures contracts all have the same thoroughly regulated, standardized contract specifications, while the two counterparties in a forward contract may customize their contract price and terms.
Contract trade: Futures trade on a public exchange, while forward contracts trade over-the-counter (OTC).
Risk factor: Clearinghouses guarantee that traders will honor futures contracts, which reduces credit default risk. Forward contracts are not guaranteed.
Hedgers: Hedgers use futures contracts to protect themselves from the price movement of an underlying asset. By making a futures contract, the hedger essentially guarantees the current market price to avoid a harmful loss if the asset price changes adversely. For example, there are constant fluctuations in oil pricing, and an oil company might enter into an oil futures contract with a buyer if they think the present-day market price of oil is higher than when their buyer would want to purchase the oil in the future. Conversely, an oil buyer worried the price of oil would rise in the future may try to lock the current oil price in with a futures contract, so they don't need to worry about negative market volatility.
Speculators: Speculators use futures contracts to bet on the futures price of an asset to profit by taking either a long position or short position. For example, a speculator who believes that the current price of gold will skyrocket might purchase gold futures at the low market price, then sell the contracts back at a higher contract price to turn a profit. Or if the speculator thinks the price of gold is inflated, they could short sell gold futures, wait until the price of gold decreases, and purchase the futures contracts back at the lower price. Speculators make educated guesses; speculating is a short-term trading strategy that's high-risk
Investors trade futures on public futures exchanges such as the New York Mercantile Exchange (NYMEX), the Chicago Mercantile Exchange (CME), and the Chicago Board of Trade (CBOT). These exchanges are part of the CME Group, which is the world's biggest financial derivatives exchange. Like a stock market exchange, the purpose of a futures exchange is to provide a structured and regulated location to conduct trades.
Most futures trades involve commodities—like oil, precious metals, or crops—but you can also trade currency, ETFs, bonds, stocks, mutual funds, and index futures on the futures exchange. The exchange has a clearinghouse that acts as the middleman for every trade on the exchange, assuming all credit risk and guaranteeing future contracts. An independent US government agency called the Commodity Futures Trading Commission (CFTC) regulates trading on all futures exchanges to prevent fraudulent futures market pricing.
A futures contract and a forward contract are both derivative contracts that agree to trade an asset between two counterparties at a specific price by a designated future date. Still, there are some critical differences between both investment types:
Contract terms: Futures contracts all have the same thoroughly regulated, standardized contract specifications, while the two counterparties in a forward contract may customize their contract price and terms.
Contract trade: Futures trade on a public exchange, while forward contracts trade over-the-counter (OTC).
Risk factor: Clearinghouses guarantee that traders will honor futures contracts, which reduces credit default risk. Forward contracts are not guaranteed.
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Equity stock futures: if you expect reliance to go up and want to buy 1000 shares but don’t have the money, then what do you do? You can buy reliance futures. Similarly, if you expect the reliance price to go down, you can also sell the reliance futures. Either way, you make profits if the price movement is in your favor, otherwise, you make a loss. Equity futures in the organized format is less than 20 years old in india. Equity futures give you leverage. You deposit an initial margin like say 20% with the broker and you can trade 5 times the money you have. Futures are only available on a selected list of stocks.
Equity index futures: if you don’t want to take the risk of stocks, you can buy or sell index futures. In india, the nifty futures and the bank nifty futures are not only popular but also extremely liquid. Index futures can be used to speculate on the movements of broad-based indices with lower risk than stock futures. Index futures can be used for hedging and arbitrage but we will not get into all that now.
Currency futures: this organized currency futures market came into india in 2008 and has become extremely popular. You can bet on currencies and protect your currency payment or receipt risk. For example, if you expect the dollar to strengthen, you buy usdinr futures and if you expect the rupee to strengthen then you sell usdinr futures. You can trade futures on dollars, pounds, euros, and yen.
Commodity futures: have been very popular but ctt has taken some sheen off commodity futures. Like the other futures, commodity futures also allow hedging against price changes in the various commodities including agricultural products, precious metals like gold and silver, hydrocarbons like oil and natural gas as well as industrial metals like aluminum, zinc, nickel, and copper. Initial margins are low in commodities so it attracts a lot of speculators. Commodity futures happen principally in mcx and ncdex in india.
Interest rate futures: interest rate futures represent a contract to buy or sell government security or t-bill at a specified price on a predetermined date. The interest yield is implied in the bond prices and you can bet on rates rising or rates falling and also hedge your interest rate risk.
Vix futures: the vix is the volatility index and you can bet on whether market volatility will go up or go down. It has nothing to do with the market direction. Vix is called the fear index and is a barometer of investor panic. Normally sharp market corrections are accompanied by a spurt in vix.
What are futures?
As the name suggests, the future is a contract that pertains to the future. In finance parlance, futures are a contract that is legal and standardized. It is an agreement to buy or sell an underlying asset at a predetermined price at a specified time in the future. Normally, this deal is between two parties not known to each other. Futures are different from forwards in the sense that forwards are customized otc products but futures are standardized exchange-traded products. On nse and bse, all futures contracts have the counter-guarantee of the clearing corporation.
What are derivatives?
In the world of finance, a derivative is a contract that derives its value from the performance of an underlying asset. In short, that is how the word derivative comes as it derives value from an underlying. This underlying can be an asset, index, or interest rate, and is often simply called the "underlying".
Derivatives contracts are typical of four categories viz. Forwards, futures, options, and swaps. These four products combined are called derivatives.
A futures contract is a legally binding contract that creates an obligation for the concerned parties to trade into an asset at a price, and on a pre-decided date. The market price of the asset at the time of expiry of the contract is not of concern in such contracts. The parties to the contract have to settle the trade compulsorily at the price set while entering into the contract. Futures contracts are standardized in nature, mentioning the price, quality, and quantity in advance so that traders can trade in them seamlessly on a futures exchange. There are many types of futures contracts that we categorize depending upon their underlying asset. The most common types of futures contracts are commodities futures, stocks and bonds futures, currency futures, interest rates futures.
The first category is of those people who use it as a tool for hedging their risk of unfavorable price movement of an asset in the future. They enter into the futures contract to fix a price for their trade. This minimizes any uncertainty as well as the risk of prices going up or down in the future.
The second category is those of speculators. They have no intention of taking the physical delivery of the asset. They look for making quick profits at the expiry of the contract by differences in the price of the asset at that date.
Futures contracts may seem similar to options as both can be settled in near future. But there is a major difference between the two. Options just give a right to trade in the asset at the time of expiry of the contract or even before. They do not create an obligation to do the same. But futures contracts create an obligation to settle the contract at the expiry of the time period.
Commodities are tangible assets that investors can physically buy and sell. The most common commodities in which investors buy futures contracts are oil, metals, natural gas, food grains, etc. The security behind such contracts is the assets themselves.
Commodities futures are very important for the management of price risk, especially to people like farmers. The primary producer of crops or the farmer can enter into a futures contract to sell his produce at a particular price at a particular date in the future. This way, he gets an assurance of the price he will get for his efforts. He can be free from the tension of losses because of the price going down in the future. Similarly, the purchaser of food grains from the farmer will also know in advance the price which he has to pay for the food grains. He can accordingly plan his production if the product is a raw material for his further production. Or he may sell the produce at a higher rate and ensure that he makes a profit from the trade. Oil and gold are other important commodities in which futures contracts play a major role globally.
Currency futures are contracts on the exchange price of currencies. The parties to the contract fix an exchange rate for the exchange of two currencies on a specific date in the future. Such contracts help to nullify the exchange rate risk that may arise in the case of international trade over a period of time. Usually, the parties close these contracts before the date of expiry as per their need.
For example, suppose Mr.X has an investment in India which is due to mature in November this year. One USD is equal to 75 INR at the current exchange rate. He can buy currency futures and lock the current exchange rate of USD to INR. Thus, he will be sure of what investment amount he will receive at this currency exchange rate, no matter what the currency exchange rate is at that time
Interest rate futures are a sort of hedging against the risk that may arise due to fluctuations in the rate of interest of a financial instrument at a future date. Uncertain interest rates may create an extra interest burden on companies and result in heavy losses. We usually use interest rates futures with a money market or bond market instruments such as government bonds, bills, etc. They are the underlying assets for such futures contracts.
Whenever there is a rise in the rate of interest, the prices of the bonds fall. Similarly, bond prices rise with a fall in the rate of interest. An investor can sell interest rates futures contract when the interest rates rise and the price of his bonds fall. They can then repurchase the bonds at a lower rate from the market. This will help them to offset some of the losses they will suffer by a fall in the price of the bonds.
Investors use single stock and stock market index futures as a tool for hedging against risks, speculations, or simply for trading. They are also an indicator of the confidence and sentiments of investors in the market. Single stock futures are a hedge against the future price of the stock. While stock market index futures track the movements of an index.
Stock futures are derivative financial contracts that create an obligation to buy or sell a stock at a specific price and date in the future. They are useful for investors who have a considerable investment in one or few stocks. They want to cover their risk position in case of an adverse stock price movement in the future.
Similarly, stock market index futures create an obligation to trade on the basis of an underlying index and its movements. They are not deliverable at the expiry of their term. Investors just settle their position on such futures in cash. They also help investors to take positions on indexes specified and hedge their risks. People use these contracts for speculative purposes as well to make quick profits as there is no physical delivery and only cash settlement.
Let's start from afar: imagine that you are a farmer and that in six months you will need grain. And that the cost of this grain may double in six months, or it may fall twice. No one knows how it will turn out.
Then you go to the supplier and agree that you will buy grain from him in six months, but at the current price. If grain becomes more expensive in six months, you will be in the black — buy it at the old price. If the grain becomes cheaper in six months, the seller will be in the black — he will sell it to you at the price of six months ago, which was higher. Here is such an agreement — and there is a futures contract. The article will talk about the same situation, but on the stock exchange.
In general, futures are a separate and very large topic that cannot be covered even by a series of articles. Therefore, in this article I will only talk about the futures of the stock section of the Moscow Stock Exchange, that is, stock and index futures. I will consider only the basic strategies of futures trading.
Be careful: this is not about long-term investments
Usually in Tinkoff magazine we talk about smart investing and long-term investments: how to make the right choice, invest money for a long time, outrun inflation and become richer over a distance of several years.
This article is about the other side of the stock markets: short-term deals, trading and speculation. The release of the article does not mean that we encourage readers to speculate on the stock exchange and take risks. But readers ask a lot of questions about futures, so we consider it our duty to tell in detail what it is and why. And whether to use the tool or not is up to you.
What is Futures
A futures contract is an agreement between a buyer and a seller to buy/sell an asset in the future. The parties agree in advance on how long and at what price the transaction will take place.
For example, now one share of Lukoil costs about 5,700 rubles. Lukoil stock futures are, for example, an agreement between a buyer and a seller that the buyer will buy Lukoil shares from the seller at a price of 5,700 rubles in 3 months. At the same time, it does not matter what the price of the shares will be in 3 months: the transaction price between the buyer and the seller will still remain 5700 rubles. If the real price of the stock does not remain the same after three months, one of the parties will suffer losses in any case.
Most futures trades are speculation. You predict that the price of Lukoil shares will rise in the near future — you buy a futures contract for Lukoil shares. You think that the price is about to collapse — you sell a futures contract for Lukoil shares.
There is one nuance in the sale of futures. In fact, "buying" and "selling" in the conversation about futures are conditional terms. The best analogy is an ordinary bet. There are two sides: one believes that the asset price will rise, and the other — that the price will fall. As a result, the first participant "buys" futures, and the second "sells" it. Accordingly, in order to sell futures, it does not need to be pre-purchased. To sell futures of a certain type, you do not even need to hold shares for which this futures is concluded — everything is simply calculated in monetary terms.
Futures is a contract of sale, but deferred. It indicates the price and the day when the contract will be executed. And when this date comes, the buyer is obliged to purchase the goods at the agreed cost. The seller, accordingly, must give this product.
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Imagine that someone is going to emigrate in six months. Our hero does not want to leave the sale of property at the last moment, so he finds a buyer for an apartment right now. At the same time, he plans to live in it until he leaves. The parties conclude a futures contract, under which the future emigrant in six months undertakes to sell housing for 1.5 million rubles.
Will it be profitable in the end? Depends on the value of the property in six months. If it goes up, the buyer wins, if it goes down, the seller wins.
On the exchange, contracts are concluded for the purchase of basic (stocks, bonds), as well as commodity (oil, gold, grain) exchange assets. And then there are futures, for example, for a currency index or an interest rate. It would seem that how can you buy a bet? Indeed, not everything is so simple.
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Delivery — when the buyer must purchase the goods on the specified date. The example with the apartment just illustrates this.
Settlement — when no one sells anything. The participants in the transaction simply pay the difference in the value of the asset, depending on how its price has changed. This arrangement is more typical for the exchange.
Almost all futures contracts on the exchange are settlement, not delivery. That is, the seller will not carry barrels of oil to the buyer during the execution of the contract. The concepts of "seller" and "buyer" are generally conditional here. It's just a bet, and asset prices are taken as a basis.
With indexes, things are on the same principle. Nobody sells them. It's just that the parties make a conditional bet on how this or that indicator will change. And whoever wins gets the money.
How futures are traded
Let's say trader A believes that oil will rise in price soon, so he is going to "buy" it on futures. And trader B is sure of the opposite: oil will soon fall in price. Therefore, he is ready to conclude a futures contract now at the current oil price.
At the same time, no one sells fuel to anyone. Moreover, the seller does not have any oil.
A and B conclude an agreement according to which the first "buys" 100 barrels of oil from the second in a week for $ 5,000 — that is, at the current price of $ 50 per barrel. On the trading accounts of both players, the exchange blocks a certain amount of money as a guarantee.
This is usually 5-15% of the contract amount, although it all depends on the variability of the asset price. This is necessary so that both players eventually fulfill the contract. The amount of the guarantee is then returned to the accounts.
Futures is a derivative financial instrument, a contract to buy/sell an underlying asset at a certain date in the future, but at the current market price. Accordingly, the subject of such an agreement (the underlying asset) may be stocks, bonds, commodities, currency, interest rates, inflation rate, weather, etc.
A simple example. The farmer planted wheat. The price of this product on the market today, conditionally, is 100 rubles per ton. At the same time, forecasts are coming from all sides that the summer will be good, and the harvest in autumn will be excellent, which will invariably cause an increase in supply on the market and a drop in prices. The farmer does not want to sell grain in the fall at 50 rubles per ton, so he agrees with a certain buyer that he is guaranteed to deliver 100 tons of grain to him in 6 months, but at the current price of 100 rubles. That is, our farmer thus acts as a seller of a futures contract.
Fixing the price of a commodity that will be delivered after a certain period, at the time of the transaction — this is the meaning of a futures contract.
Derivative financial instruments appeared together with trading. But initially it was a kind of unorganized market based on verbal agreements between, for example, merchants. The first contracts for the supply of goods at some point in the future appeared together with the letter. So, already on cuneiform tablets of centuries BC, which were found during excavations of Mesopotamia, one can find a kind of prototype of futures. By the beginning of the 18th century, the main types of derivative financial instruments appeared in Europe, and capital markets acquired the features of modern ones.
In Russia today, futures can be traded on the futures market of the Moscow Stock Exchange — FORTS, where one of the most popular instruments is futures on the RTS index. The volume of the futures market around the world today significantly exceeds the volume of real trading in underlying assets.
BCS is the market leader in terms of turnover in the FORTS futures market. Earn with us!
Start trading on the futures market
Technical Details
Each futures contract has a specification — a document fixed by the exchange itself, which contains all the main terms of this contract: — name; — ticker; — type of contract (settlement /delivery); — size (number of units of the underlying asset per futures); — circulation period; — delivery date; — minimum change prices (step); — the cost of the minimum step.
So, the futures for the RTS index are currently trading under the ticker RIZ5: RI is the code of the underlying asset; Z is the code of the month of execution (in this case December); 5 is the code of the year of execution of the contract (the last digit).
Full information on the specification of futures short codes on the FORTS futures market can be viewed directly on the website of the Moscow Exchange.
Futures contracts are "settlement" and "delivery". The delivery contract implies the delivery of the underlying asset: we agreed to buy gold at a certain price in 6 months — get it, everything is simple here. The settlement futures does not involve any delivery. After the expiration of the contract, the profit / loss is recalculated between the parties to the contract in the form of accrual and write-off of funds.
Example: We bought 1 futures on the Russian RTS index, assuming that by the end of the contract period, the domestic index will grow. The circulation period has ended, or, as they often say, the expiration date has come, the index has grown, we have accrued profit, no one has supplied anything to anyone.
The maturity of a futures contract is the period during which we can resell or buy back this contract. When this period ends, all participants in transactions with the selected futures contract are required to fulfill their obligations.
The futures price is the current contract price. During the life of the contract, it changes, up to the expiration date. It is worth noting that the price of a futures contract differs from the price of the underlying asset, although it has a tight direct dependence on it. Depending on whether futures are cheaper or more expensive than the price of the underlying asset, situations called "contango" and "backwardation" arise. That is, some circumstances that may occur are included in
today's price, or in general, the mood of investors about the future of the underlying asset.
Advantages of Futures trading
- A trader gets access to a huge number of instruments traded on different exchanges around the world. This provides opportunities for broader portfolio diversification.
- Futures have high liquidity, which makes it possible to apply various strategies.
- Reduced commission compared to the stock market.
- The main advantage of a futures contract is that you do not have to put out as much money as you would have to when buying (selling) the underlying asset directly. The fact is that when performing an operation, you use a warranty (GO). This is a refundable fee that the exchange charges when opening a futures contract, in other words, a kind of collateral that you leave when making an operation, the amount of which depends on a number of factors. It is not difficult to calculate that the leverage that is available in futures transactions allows you to increase the potential profit many times, since the GO is often noticeably lower than the value of the underlying asset. However, do not forget about the risks.
It is important to remember that GO is not a fixed value and can change even after you have already bought a futures contract. Therefore, it is important to monitor the status of your position and the level of GO, so that the broker does not close your position at a time when the exchange has slightly increased the GO, and there are no additional funds in the account at all. The BCS company provides an opportunity to its customers to use the "Reduced GO" service. Access to trading on the futures market is provided on QUIK or MetaTrader 5 terminals.
Trading Strategies
One of the main advantages of futures is the availability of various trading strategies.
The first option is risk hedging. Historically, as we have already written above, it was this option that gave rise to this type of financial instrument. The first basic asset was various agricultural products. Not wanting to risk their income, farmers sought to conclude contracts for the supply of products in the future, but at the prices agreed now. Thus, futures contracts are used as a way to reduce risks by hedging both real activities (production) and investment operations, which is facilitated by fixing the price of the asset we have chosen right now.
Example: now we are seeing significant fluctuations in the foreign exchange market. How to protect your assets during periods of such turbulence? For example, you know that in a month you will receive revenue in US dollars, and you do not want to take the risk of currency exchange rate changes during this period of time. To solve this problem, you can use a futures contract for the dollar / ruble pair. Let's say you expect to receive $10 thousand and the current exchange rate satisfies you. In order to hedge yourself against an undesirable change in the exchange rate, you sell 10 contracts with an appropriate execution date. Thus, the current market rate is fixed, and if it changes in the future, it will no longer affect your account. The position is closed immediately after you receive real money.
Or another example: You have a portfolio of Russian blue chips. You plan to hold the shares for a long time, more than three years in order to be exempt from personal income tax. But at the same time, the market has already grown quite high and you understand that a downward correction is about to happen. You can sell futures on your shares or the entire MICEX index as a whole, thereby insuring yourself from the market fall. If the market declines, then you can close your short positions in futures, thereby leveling the current losses on the securities available in the portfolio.
Speculative operations. The two main factors contributing to the growth of the popularity of futures among speculators are liquidity and a large "leverage".
The task of the speculator, as you know, is to profit from the difference in the purchase and sale prices. Moreover, the profit potential here is maximum, and the terms of holding open positions are minimal. At the same time, in favor of the speculator, there is also such a moment as a commission reduced in comparison with the stock market.
Arbitrage operations are another option for using futures, the meaning of which is to make a profit from "playing" on calendar/inter-commodity/inter-market spreads. Learn more about arbitration operations.
To learn more about futures trading, you can read books — for example, Todd Lofton's "Fundamentals of Futures Trading". In addition, you can attend various webinars for beginners.