What are futures and why are they bad for investing

It is a complex financial instrument not suitable for beginners.

What are the future

Futures is a sale contract, but deferred. It indicates the price and the date of the contract execution. And when this deadline comes, the buyer is obliged to purchase the goods at the agreed price. Accordingly, the seller must provide this product.

Will it be profitable in the end? Depends on the value of the property in six months. If it rises, the buyer wins, if it falls, the seller wins.

Contracts for the purchase of basic (shares, bonds) and commodity (oil, gold, grain) assets are concluded on the stock exchange. There are also futures contracts, for example on the currency index or the interest rate. It would seem, how can you buy a bet? Indeed, not everything is so simple.

Futures contracts are of two types:

  1. Delivery - when the buyer has to purchase the goods within a certain period. The example with the apartment only illustrates this.
  2. Settlement - when nobody sells anything. The participants of the transaction simply pay the difference in the value of the asset, depending on how its price has changed. This alignment is more typical of an exchange.
Almost all futures contracts on the exchange are cleared, not delivered. This means that the seller, when fulfilling the contract, will not deliver barrels of oil to the buyer. The concepts of "seller" and "buyer" are generally conditional here. This is just a bet and asset prices are taken as the basis.

Everything looks the same with indexes. Nobody's selling them. It's just that the pages contain a conditional bet on how this or that indicator will change. And whoever wins gets money.

How futures are traded

Let's say trader A believes the price of oil will rise soon, so he intends to "buy" it in futures. And trader B believes the opposite is true: the price of oil is about to fall. Therefore, it is now ready to enter into a futures contract at the current oil price.

At the same time, nobody is selling fuel to anyone. In addition, the seller does not have any oil.

A and B reach an agreement whereby the former "buys" the second 100 barrels of crude oil in a week for $ 5,000 - which is the current price of $ 50 a barrel. In the trading accounts of both players, the exchange holds a certain amount of money as collateral.

Usually it is 5-15% of the contract amount, although it all depends on the volatility of the asset price. This is necessary for both players to finally fulfill their contract. The amount of the guarantee is then credited back to the accounts.

A week later, crude oil is $ 55 a barrel. And the "seller" loses an amount that was not counted if he sold real fuel - $ 500. This amount from his account goes to the account of buyer A.

This does not mean that you can buy futures and wait calmly until the contract expires to convert everything.

Settlements, i.e. settlements, are carried out on a daily basis. Depending on the change in the value of the asset, money from one player's account will be transferred to another's. For example, if the day after the conclusion of the contract, oil prices fell by 1%, then PLN 50 from account A is transferred to account B.

It is worth remembering that a futures position can be closed at any time ahead of schedule - sell bought earlier or cancel sold.

Why buy asset futures when you can only buy assets

Logical question: if success or failure depends on how the price of the underlying has changed, why not buy it right away? The Dean of the Faculty of Economics and Business of the University of Finance explains with an example.

Suppose the share of Company X sells today at 100 on the stock exchange. You are sure the price will rise. The forecast works, the stocks are worth 105, your profit is 5.

However, you could take the risk and buy a future that also costs 100. But we already know that 5–15% of the value of the underlying assets is enough to buy a futures contract. Let's say that in our case it is 10%, which is 10. Therefore, for 100 you can buy ten futures instead of one share. And if the share price is 105 at the end of the deal, the buyer will get 50 from the deal.

What's the catch? In fact, we often make mistakes in our forecasts. And the losses associated with futures contracts are as large as the potential gains.

Why do we need futures when the risk is so high?

Trading futures is purely speculative. Lottery is much closer than investing. Based on objective indicators, an asset's price change can be assumed. But the will to chance is of great importance here.

This is a way of earning money for traders - people who are actively involved in trading on the stock exchange. They make frequent short-term trades and try to take advantage of them. For them, futures have advantages:

In addition, by selling futures, you can hedge your securities portfolio, i.e. hedge against market shocks. For example, an investor has a stake in Company X that is currently worth 100. He hopes the price will rise, but is not sure. Therefore, he sells them futures. In effect, if the stocks rise, it will make a profit on them. If they drop, futures will pay off.

Why you probably shouldn't mess with the futures

If you are an active trader and spend a lot of time trading the stock market, you already know everything about futures and you can see the risks associated with such transactions. For those who are just starting to invest or choose a passive investment strategy with minimal body movements, this is not suitable. And that's why.

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