In this paper we will discuss about Futures, a derivative instruments. There are some similarities between futures and forwards, for both of them are derivative instruments. Futures provide an efficient tool for hedging. Futures are standardized, that is they can be traded only on those contracts, which are supported by the exchange.
Like Forward, Futures are also exchange-traded derivatives. Futures represent a trade agreement, to buy or sell an asset for an agreed price, which will be taken place in future. The entire futures contract has a final trading date, which is specified only by the exchange.
Futures offer a very handy tool for speculation or hedging. Unlike the Forwards, Futures are standardized derivative instruments, that is, only those contracts can be traded which are facilitated by the exchange. That means futures are not flexible. Futures only have to combat the market risks, and not the credit risks.
A future is traded through a brokerage firm, which holds a “seat” on the trade exchange, that is, the brokerage firm acts as a middleman between the two parties. Before one party starts future trading, the broker takes a deposit from that party which is termed as “initial margin”. The exchange itself sets the amount of initial margin.
Every day’s gain or loss is determined on the position of the future. If a loss is incurred then, the broker takes the money from the above mentioned initial margin fund and then sends it to the exchange whereas, in case of a profit, the money is transferred to that marginal account.
Futures are very popular in most of the commodity and energy markets, but in some markets the rules of exchange do not synchronizes with the party’s needs. Therefore, the party has to negotiate the terms of Future privately and then reverse the position of its Future by using the Offsets.
Last Updated on : 1st August 2013