What is a futures contract?

A futures contract is an agreement between a buyer and a seller in which the buyer needs to buy (the seller needs to sell) an asset at a preset price and deliver it at some point in the future.

HOW TO WORK

Assets commonly sold in futures contracts include commodities, stocks, and bonds. Nuts, precious metals, electricity, oil, beef, orange juice and natural gas are prime examples of commodities. But foreign currencies, bandwidth, and some specific financial instruments today can also be viewed as commodities in the market.

There are two main types of sellers for this type of contract. Type 1 does not seek to profit through goods but aims to achieve stability in revenue or costs of doing business. Profit or gain will usually offset each other to some extent according to the loss and gain in the market for the underlying physical commodity.

For example, you plan to plant 500 bushels of wheat next year. You can grow wheat and then sell it at any price at harvest, or you can lock in prices by selling a futures contract, whereby you need to sell 500 bushels of wheat at a predetermined price. By locking in prices for the time being, you can avoid the risk of wheat devaluation. On the other hand, if the crop isn’t doing so well and the supply of wheat decreases, prices will likely go up – but you’ll still only get the money you locked into the contract. If you were a bread maker, you would probably buy this futures contract. However, you may be overpaying and (hopefully) underpaying for the wheat based on the price scale when you receive the wheat.

The second type of seller is usually not interested in the underlying asset. They bet on the future value of certain commodities. Therefore, if you disagree with your counterparty that the price of wheat will fall, you can buy a futures contract. If your prediction is correct, the price of wheat rises, you will profit from the futures contract. Type 2 is often criticized for causing prices to go up and down sharply. But they bring liquidity to the futures market.

Futures contracts are standardized, that is, they specify the quality, volume, and delivery of the underlying commodity so that the value is equal to everyone else in the market. For example, each type of crude oil (e.g. light grade) needs to meet certain quality criteria so that crude from one producer is similar to another, and buyers know they are getting it. get something.

The ability to sell futures contracts is based on the payment member, the party that manages the payment between the buyer and the seller. The paying member can be a large bank or financial services company. They insure the contract and, therefore, require the parties to pay a deposit (also known as a margin) to ensure the buyer has enough capital to deal with potential damages. The risk created by the payer makes the contract’s quality, volume and delivery requirements more stringent.

WHY IMPORTANT SMART CONTRACT?

A smart contract is a zero-sum game (one person wins, the other loses). If someone is making a billion dollars, someone is also losing a billion dollars. And this downside is very difficult to limit. Since futures contracts can be sold on margin, meaning the investor buys the contract with a portion of the debt from the broker, the buyer has a strong leverage to buy a contract worth thousands or thousands of dollars. million dollars with very little of his own money.

Furthermore, futures contracts require daily due diligence. That is, if the futures contract is bought on an out-of-the-money margin (you expect the price to rise but the price will fall) on a certain day, the holder of the contract needs to redefine the shortfall that day. . Unforeseen price changes for the underlying asset and marginal usability make futures a risky game that requires a great deal of skill, knowledge, and risk taking.

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