A futures contract is an agreement to buy or sell a particular currency, commodity or financial instrument at a predetermined price at a specified time in the future. Hedgers and speculators are two major categories of market participants.
In futures trading, both parties will be entitled to respective rights and obligations. For example, the Buyer and the Seller of futures conclude a cotton futures contract at a unit price of USD 70. The Buyer of futures hence is entitled to the rights and obligations of buying 10 tons of cottons at the price of USD 70 per pound on a certain date. Likewise, the Seller is also entitled to the rights and obligations of selling the cottons at the price of USD 70 per pound on a certain date. The contract representing the rights and obligations of both parties is a futures contract.
Where did it originate?
The first exchange to facilitate trading for cryptocurrency futures contract market is OKCoin. The original purpose is to provide a derivative to hedge risk for Bitcoin miners which then evolved to other cryptocurrencies and investors.
Why should I care?
Investors are able to eliminate the uncertainty having to do with expected profits and expenses by engaging in the futures contracts to lock in a price for which you are able to buy or sell. Futures contracts state the quality and quantity of the underlying asset. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. Most of the time, investors may not actually fulfil the rights and obligations of the futures contract. Instead, they choose to close their positions and take profits before the contract comes into effect (prior to the delivery date).
How is it applied in real life?
The ultimate goal of using futures contracts is to hedge ones’ risk and protect themselves from the price fluctuations. The amount of leverage an exchange offers varies from product to product. Leverage is determined by the Initial Margin and Maintenance Margin levels. In order to enter and maintain positions, investors are required to hold a specific minimum equity. Investors use futures for speculation as well as hedging.
Futures Speculation
Market participants use futures contracts to manage potential price fluctuations of the underlying assets. With the leveraging power, market participants could possibly make profits by purchasing the asset in a futures contracts and shorting it later at a higher price on the spot market. Market participants can hence benefit from the favourable price difference if they expect the price of underlying asset will increase. On the other hands, market participants could short a futures contracts of the asset and buy it back later at a lower price on the spot market.
Futures Hedging
Market participants have futures contracts to hedge the potential losses from price movements. They are usually the individuals who are in the business of actually using or producing the underlying asset in a futures contract. If they could gain from the futures contracts, that mean they suffer from a loss in the spot market, or vice versa. The acceptable current market price is locked effectively with such a gain and loss offsetting each other.
