What is future contract?

Finance ManagementBanking & FinanceGrowth & Empowerment

A future contract is the contract between a buyer and a seller, where the buyer agrees to buy a particular asset at a predetermined price. Buyer in the future contract will hold a long position and the seller will have a short position.

Future contracts allow companies to hedge their risk associated with the interest rates, exchange rates and business risk with commodity prices. Future contract helps investors to obtain exposure to a stock or a bond or a market (stock) index or any other financial assets.

Features

The features of future contract are as follows −

  • Organised exchanges − These are traded in an organised exchange in a particular physical place.

  • Standardisation − Both delivery and maturity date are standardised by exchange.

  • Clearing houses − Clears all contracts which are struck on the trading floor.

  • Margins − Only register members are allowed to trade. They can trade for both self and for a client.

  • Marketing to market − Profit or loss over the period is split into a daily basis of profit and loss.

  • Actual delivery − Actual delivery in most future markets is rare (less than 1% of traded contracts).

Types

The types of future contract are as follows −

  • Stock futures.

  • Currency futures.

  • Commodities future.

  • Index future.

Advantages

The advantages of the future contract are as follows −

  • Investors can participate in markets (not have access to them).

  • Stable margin.

  • Traders should not worry about time decay (value of assets declines and reduces profits to traders).

  • High liquidity.

  • Easy to understand.

  • Protect against price fluctuations.

  • Better risk management.

Disadvantages

The disadvantages of the future contract are as follows −

  • No control over future events.

  • High leverage.

  • Expiration date.

raja
Updated on 18-May-2022 08:07:57

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