Futures markets have been described as continuous auction markets and as clearing houses for the latest information about supply and demand. They are the meeting places of buyers and sellers of an ever-expanding list of commodities that today includes agricultural products, metals, petroleum, financial instruments, foreign currencies and stock indexes. Trading has also being imitated in future contracts , enabling option buyers to participate in future market with known risks. In other words Futures markets have been described as continuous auction market and as a clearing house for the latest information about supply and demand.
Participants in Future Market
The following are the participant in future market which are as follows:
- Hedgers: Hedgers are individuals and firms that makes purchases and sales in the future market solely for the purpose of establishing a known price level –weeks or month in advance -for something they later intended to buy and sell in the cash market in this way they attempt to protect themselves against the risk of unfavorable price change in the interim .Hedgers may use futures to lock in an acceptable margin between their purchases price and their selling price
- Speculators: Speculators are individuals and firms investors who accept the risk. In other words the speculator are individual and firms who seek to profit from anticipated increase or decrease in future price . Someone who expects a future price to increase would purchase futures contracts in the hope later being able to sell them at a higher price ,this is known as “going long”, while on the other hand someone who expects a future price decline would sell futures contracts in hope of later being able to buy back identical and offsetting contacts at lower price , the practice of selling futures contracts in anticipation of lower price is known as “going short”. Most of the speculative investor have no intention of making or taking delivery of the commodity but, rather seek to profit from a change in the price .
- Floor traders: Floor traders are person who buy and sell for their own accounts on the trading floors of the exchange and are the least known and understood of all futures market participants ,Actually they have no guarantee they will realize a profit , they can loss of money on any trade, basically the floor trader make more liquid and competitive market
Futures contract involves obligations of both parties to perform in the future–the buyer (long) to purchase the asset underlying the future and the seller (short) to deliver the asset. Thus, both the buyer and the seller of a futures contract must initially post and maintain, on a daily basis, margin to assure contract performance and the integrity of the marketplace. In other words Futures contract is the agreement between two parties to buy or sell an asset at a certain time in the future for a certain prices. It is normally traded in the exchange
Forward contracts are bilateral contracts to manage price risk and quantity risk to certain extent and would act as a boost for futures markets for the following reasons
Need of Futures Trading
Futures trading in commodities results in and fair price discovery on account of large-scale participations of entities associated with different value chains. It reflects views and expectations of a wider section of people related to a particular commodity. It also provides effective platform for price risk management for all segments of players ranging from producers, traders and processors to exporters/importers and end-users of a commodity. It also provides hedging, trading and arbitrage opportunities to market players.
Types of Futures Contract
There are two types of futures contracts which are as follows
- Physical delivery of commodity contracts: in this type of futures contract the physical delivery of the commodity is based on the desire of the buyer and seller both at the time of contract expired.
- Call for a cash settlement contracts: Cash settlement futures contracts are precisely that contracts which are settled in cash rather than by delivery at the time of the contract expired.
How To Choose The Future Contract
The market of for one commodity may be highly volatile at one time but not highly volatile at another time. The investor must consider following thing while choosing any future contract which are as follows:
- Liquidity : A liquid market will exist for offsetting a futures contract that investor have previously brought or sold , two useful indicator of liquidity are the volume of trading and the open interest
- Timing: In future trading it is necessary to anticipate the timing of the price change which may reflect the decision of the investor
- Stop Orders : A stop order is an order , placed with broker to buy or sell a particular future contract at the market price if and when the price reaches a specified level stop order are often used by future traders in an effort to limit the amount they have
- Spreads : Spread involves buying one future contract and selling another future contract , the main purpose is to profit from an expected change in the relation ship between the purchase price of one and the selling price of the other. In other words the spread involves the purchases of one futures contract and the sale of a different future contract in hope of profiting from a widening or narrowing of the price difference.
- Options on futures contracts: The Put and Call option are being traded on a growing number of future contracts. The main principal attraction of buying an option is that they make it possible to speculate to increase or decrease future price with a known and limited risk. In call option buyers acquires the right but not the obligation to purchase a particular futures contract at a specified price at any time during the life of the option. A Put option convey the right to sell a particular futures contract at specified price , put option can be purchased to profit from an anticipated price decrease.
The Process of Price Discovery
The process of price discovery in futures contract is continuous. The price of future increases and decreases largely because of the myriad factors that influence buyers and the seller’s judgment about what a particular commodity will be worth at a given time in the future. With the arrival of new or more accurate information the price of the futures contract might increase or decreases in response to changing expectations
As a new supply and demand development occurs as new and more current information becomes available, these judgments s are reassessed and the price of a particular future contract may be bid upward and downward
After The Closing Bell
Closing bell signals the end of a day’s trading , the exchange’s clearing organization matches each purchase made a day with the corresponding sales and tallies each member firm gain or losses based on that day’s price change , a massive undertaking considering that near two-third of a million futures contracts are bought and on an average day. Gains and losses on futures contracts are calculated on daily basis and they are credited and debited on a daily basis.
An absolute requisite for any one considering trading in futures contracts that to clearly understand the concept of leverage as well as the amount of gain and loss that will result from any given change in the futures price of the particular futures contract in which you are liking to deal. If you cannot afford the risk, or even you are not comfortable with the risk then it is not suitable to trade in futures
Margins are basically the sum of money deposited by the investors towards his trader or broker on his/her good faith.
In futures trading the margin is required to buy or sell a futures contract is on solely a deposit of good faith money that can be drawn on by brokerage firm to cover loss that incurred by the investor in course of future trading. The minimum level of margins for a particular futures contract at a particular point of time is set by the exchange on which the trading take place. Exchange continuously monitor market condition and risk and as necessary, raise or reduce the margin requirements .Individual brokerage firm may charge or require higher margin amount from their customers than the exchange set minimum.
There are two types of margins
- Initial Margin: Initial Margin is the sum of money that the customer must deposit with the brokerage firm for each future contract to brought or sold .If on any day that profit accrues on investor open position, the profit will be added in the balance of investors margin account
- Maintenance Margin: Maintenance Margin is the additional amount which is required to deposit by investor on call by brokerage firm due to losses suffered in previous future contract to get the margin to the level of initial margin. when brokerage firm call for additional margin is called margin call
In short and simple words Maintenance Margin is the minimum margin balance which must be maintained by investor with brokerage firm to reduce losses at a certain level .
There are various of the different strategies and variation of strategies are used in future trading for getting speculative profit in short time , some of the strategies are as follows :
- Buying (Going Long) to profit from an expected price increase
- Selling (Going Short) to profit from an expected price decreases
Buying (Going Long) to profit from an expected price increase : In this view the investor expecting the price of a particular commodity or item to increase over from a given period of time can seek to profit by buying futures contract. If forecasting is in correct direction and timing of the price change s, the future contract can later be sold for the higher price , there by yielding a profit, if on the other hand price decline rather than increase , the trade will result in a loss.
Selling (Going Short) to profit from an expected price decreases: In this strategy the investor sells the future contract if he/she expecting a decline in the price of the future so that a profit can be realized by later purchasing an offsetting future contract at the lower price.
Spread : Spread involves buying one future contract and selling another future contract , the main purpose is to profit from an expected change in the relation ship between the purchase price of one and the selling price of the other.
Method of Participating In Future Trading
The method of participating in future trading is based and depend on the need and want of the investors in making trading decision as well as his/her perceptions like from this we can categories the method of participating in future trading in four categories which are as follows :
- Trade your own account
- Have someone manage your account
- Use a commodity trading adviser
- Participation in a commodity pool
Trade your own account : Under this method the investor has to open his/her individual trading account , with or with out the recommendation of the brokerage firm , in which the investor take sole decision regarding trading decisions , investor will also responsible for assuring that adequate fund s are on deposit with the brokerage firm for margin purposes and the such funds are promptly provided as needed. An individual trading account can be opened either directly with a future commission Merchant or indirectly through an introducing broker. Future Commission Merchant are required to maintain the funds and property of their customer in segregated account (Separate from the firm’s own money). Introducing broker do not accept or handle investor funds but most offer a variety of trading-related services.
Have someone manage your account: A managed account is also an individual account. The major difference is that investor give someone rise to an account manager in which written power of attorney is made in favors of account manger to make and execute decisions about what and when to trade . He or she will have discretionary authority to buy or sell for investor account or will contract investor for approval to make traders he or she suggests in this case the investor remain fully responsible for any losses which may incurred and as necessary ,for meeting margin calls , including making up any deficiencies that exceed your margin deposit.
Use a commodity trading advisor: A commodity trading advisor is a individual that take a fee and provide advice on commodity trading, include all specific recommendation such as when to establish a particular long or short position and when to liquidate that position , trading recommendation may be communicated by phone , wire mail.
Participation in a commodity pool : Another alternative method of participating in the future trading is through future trading, it is only the method of participation in which investor will not have his own trading account , in fact his money will be combined with that of other pool participants b and in effects traders as a single account . Investor share in the profit or losses of the pool in proportion to his/her investment in the pool. One potential advantage is greater diversification of risks than investor might obtain if investor were to establish his own trading account. Another advantage is that the investor risk of loss is generally limited to his/her investment in the pool , because most pools are formed as limited partnerships a pool must execute all of its trades through a brokerage firm which is registered with the CFTC as a Future commission Merchant , it may or may not have any other affiliation with brokerage firm .Some brokerage firms, to serve those customers who prefer to participate in commodity trading through a pool , either operate or have a relationship with one or more commodity trading pools.
What are the Requisite in Future Contract
Future contract is wide contract contain various thing but the following are the some of the requisite of future contract and must be considered by the investor before making any decision of investment in the future which are as follows :
- The Contract Unit: The Contract Unit specifies that how much quantity is contracted in the future contract to make settlement at the expiration of the future contract.
- Quotation of price: Future price are usually quoted the same way price are quoted in the cash market while the cash settlement contract prices are quoted in terms of an index number , usually stated to two decimal points
- Minimum Price Change: Exchanges establish the minimum amount that the price fluctuates upward or downward. The process of establishing the minimum amount by exchange is known as “TICK”
- Daily Price Limits : Exchange establishes daily price limits for trading in future contracts , the limits are stated in terms of the previous day’s closing price plus and minus so many cost per trading unit . Once a future price has increased by its daily limit , there can be no trading at any higher price until the next day of trading , if on the other hand if the futures prices has declined by its daily limit there can be no trading at any lower price until the next day of trading. The daily Price Limits set by the exchange is subject to change
- Position Limit : Exchanges and the CFTC establish limits on the maximum speculative position that one person have at one time in any one future contract, the main purpose is to prevent one buyer or seller from being able to exert undue influence on the price in either the establishment or liquidation of positions, Position limits are stated in the number of contracts or total units of the commodity.