An Introduction to a Futures Contract

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Futures exchanges focus on the buying and selling of futures contracts which are essentially another form of derivative contract. With the futures contract you are in a position to make or take delivery of a financial or non-financial asset according to the applicable terms.

The distinction between such contracts and option grants is that a contract has a mandatory effect on the transactions which you engage in. While options only cover the rights towards the transaction without necessarily taking a position under obligation.

Futures contracts are also referred to as exchange traded derivatives, and relevant margins to these contracts traded on an exchange are determined by the clearing house which forms part of the futures exchange.

Although futures are not securities in their own right as with stocks and other types of securities, they entail the trading of particular commodities on a specific date in the future (i.e, delivery date or settlement date) based on the final agreed price.

And just like in any other market or exchange, prices in this domain are influenced by the forces of supply and demand. Financial futures relate to what could be termed as financial commodities and have a clear distinction to the ordinary commodities that are traditionally associated with this term.

As such financial futures can be currencies, stock indexes, interest rates, securities or financial instruments.

Another related futures product is the forward contracts which are also geared towards delivering a financial or non financial asset on a predetermined date or price. However, you will not find forwards on the exchange platform, instead they are traded over-the-counter.

And also futures come with margins set by the exchange’s clearing house, but forwards do not share this aspect – margins have the advantage of lowering the risk associated with credit. Additionally, forwards are designed in such a way that they face a non-exchange counter party, and futures work on the opposite end of this characteristic stick, they are standardized meaning they face on the exchange platform.

Unlike forwards which present the trader with many risky elements, the futures come with reduced risk levels as regards losses such as settlement failure which does not become the burden of the individual party but the exchange itself.

Conversely, large balances can accrue up to the final settlement day on the part or account of the individual were forwards are concerned. Standardization employed with the futures fosters liquidity in the market.

For an individual to establish or place a position on the futures, an initial margin or equity is needed and serves as a performance bond. In turn the exchange will set the percentage or margin for all exchange based transactions.

 

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