Let's see how this investment avenue works for investors, consumers and exporters
In the current market scenario, you can invest a part of your portfolio in futures. More individual investors are looking at this segment. You can diversify your investment portfolio by investing in futures.
Futures contracts are not 'direct' securities such as stocks, bonds, rights or warrants. They are still securities, however, though they are a sort of derivative contracts. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position.
Futures is used both as a speculative and hedging tool. They provide leverage to take greater risks. By paying small premiums, you can take higher risks, and expect higher returns as well. At the same time, the downside risks are inherent in such contracts.
The pricing of futures depends on the underlying spot prices, interest rates, income from the underlying assets etc. The price is determined by the instantaneous equilibrium between the forces of supply and demand among competing buy and sell orders on the exchange at the time of the purchase or sale of the contract.
Futures trading is an agreement between a buyer and a seller obligating the seller to deliver a specified asset of specified quality and quantity to the buyer on a specified date at a specified place. The buyer is obligated to pay the seller a pre-negotiated price in exchange of the delivery.
In futures trading, the contracting parties negotiate on not only the price at which the commodity is to be delivered at a future date but also on what quality and quantity is to be delivered. Futures trading is usually carried out on a futures exchange.
A future is a derivative contract like an option. It is a financial contract asserting the sale of stocks or physical commodities for future delivery. The future market is an ideal place for potential buyers and sellers to meet and enter into future contracts. Futures pricing can be either based on an open cry system or electronically matched bids and offers. The initial margins are significantly smaller as against a contract's cash value. Hence, the futures positions are considered highly leveraged.
The smaller the value of margin in comparison to the cash value of a futures contract, the higher the leverage.
Options on futures contracts limit losses while maintaining the possibility of yielding good profits. The buyer pays a premium in return for a right to buy or sell, within a time period at a predetermined price known as strike or exercise price. Margin, in a futures contract, implies the starting deposit made into an account to enter the futures market. The initial margin is the minimum amount required to enter the futures market while the maintenance margin is the lowest amount possible to be reached before replenishing the account. Upon liquidation of the contract, you will receive the principal amount plus or minus any gains or losses as the case may be. Hence, the amount in the margin account changes as per the market.
Futures helps in the process of proper price discovery and hedging of price risk with reference to a given commodity. They are useful to producers because they can get an idea of the price likely to prevail at a future point in time and therefore can decide between various competing commodities. It also helps a consumer get an idea of the price at which a commodity will be available at a future point in time. The consumer can evaluate costing and also cover his purchases with forward contracts. Further, it provides exporters with an indication of prices likely to prevail and thereby helps them in quoting a realistic price and secure export contracts in a competitive market.
At the same time, it is to be noted the futures market is highly risky.
