Forward contract là gì

Essentially, forward & futures contracts are agreements that allow traders, investors, & commodity producers to lớn speculate on the future price of an asset. These contracts function as a two-buổi tiệc ngọt commitment that enables the trading of an instrument on a future date (expiration date), at a price agreed upon at the moment the contract is created.

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The underlying financial instrument of a forward or futures contract can be any asset, such as equity, a commodity, a currency, an interest payment or even a bond.

However, unlike forward contracts, the futures contracts are standardized from a contract perspective (as legal agreements) & are traded on specific venues (futures contracts exchanges). Therefore, futures contracts are subject khổng lồ a particular set of rules, which may include, for instance, the kích cỡ of the contracts & the daily interest rates. In many cases, the execution of futures contracts is guaranteed by a clearing house, making it possible for parties khổng lồ trade with reduced countertiệc nhỏ risks.

Although primitive forms of futures markets were created in Europe during the 17th century, the Dōjima Rice Exchange (Japan) is regarded as the first futures exchange to lớn be established. In early 18th-century nhật bản, most payments were made in rice, so futures contracts started to lớn be used as a way lớn hedge against the risks associated with unstable rice prices.

With the emergence of electronic trading systems, the popularity of futures contracts, along with a range of use-cases, became widespread across the entire financial industry.

Functions of futures contracts

Within the financial industry context, futures contracts typically serve some of the following functions:

Hedging và risk management: futures contracts can be utilized lớn mitigate against a specific risk. For example, a farmer may sell futures contracts for their products lớn ensure they get a certain price in the future, despite unfavorable events & market fluctuations. Or a Japanese investor that owns US Treasury bonds may buy JPYUSD futures contracts for the amount equal lớn the quarterly coupon payment (interest rates) as a way lớn lock the value of the coupon in JPY at a predefined rate và, thus, hedging his USD exposure.
Leverage: futures contracts allow investors to lớn create leveraged positions. As contracts are settled at the expiration date, investors are able lớn leverage their position. For example, a 3:1 leverage allows traders khổng lồ enter inkhổng lồ a position three times larger than their trading tài khoản balance.
Short exposure: futures contracts allow investors to lớn take a short exposure to an asphối. When an investor decides khổng lồ sell futures contracts without owning the underlying asmix, it is commonly referred lớn as a “naked position”.
Asset variety: investors are able to lớn take exposure khổng lồ assets that are difficult lớn be traded on the spot. Commodities such as oil are typically costly lớn deliver and involve sầu high storage expenses, but through the use of futures contracts, investors & traders can speculate on a wider variety of asset classes without having lớn physically trade them.
Price discovery: futures markets are a one-stop-cửa hàng for sellers and buyers (i.e. supply & demand meet) for several asphối classes, such as commodities. For example, the price of oil can be determined in relation lớn real-time demand on futures markets rather than through local interaction at a gas station.

Settlement mechanisms 

The expiration date of a futures contract is the last day of trading activities for that particular contract. After that, trading is halted and the contracts are settled. There are two main mechanisms for futures contracts settlement:

Physical settlement: the underlying asphối is exchanged between the two parties that agreed on a contract at a predefined price. The buổi tiệc ngọt that was short (sold) has the obligation lớn deliver the asset khổng lồ the tiệc ngọt that was long (bought).
Cash settlement: the underlying asmix is not exchanged directly. Instead, one các buổi party pays the other an amount that reflects the current asmix value. One typical example of a cash-settled futures contract is an oil futures contract, where cash is exchanged rather than oil barrels as it would be fairly complicated to physically trade thousands of barrels.

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Cash-settled futures contracts are more convenient và, therefore, more popular than physical-settled contracts, even for liquid financial securities or fixed-income instruments whose ownership can be transferred fairly quickly (at least comparing khổng lồ physical assets lượt thích barrels of oil).

However, cash-settled futures contracts may lead to lớn manipulation of the underlying asmix price. This type of market manipulation is commonly referred to as “banging the close” - which is a term that describes abnormal trading activities that intentionally disrupt orders books when the futures contracts are getting cthua trận lớn their expiration date.

Exit strategies for futures contracts

After taking a futures contract position, there are three main actions that futures traders can perform:

Offsetting: refers to lớn the act of closing a futures contract position by creating an opposite transaction of the same value. So, if a trader is short 50 futures contracts, they can open a long position of equal kích thước, neutralizing their initial position. The offsetting strategy allows traders khổng lồ realize their profits or losses prior to the settlement date.
Rollover: occurs when a trader decides to open a new futures contract position after offsetting their initial one, essentially extending the expiration date. For instance, if a trader is long on 30 futures contracts that expire in the first week January, but they want lớn prolong their position for six months, they can offmix the initial position & open a new one of the same kích cỡ, with the expiration date phối to the first week of July.
Settlement: if a futures trader does not offphối or rollover their position, the contract will be settled at the expiration date. At this point, the involved parties are legally obligated to exchange their assets (or cash) according lớn their position.

Futures contracts price patterns: contango và normal backwardation

From the moment futures contracts are created until their settlement, the contracts market price will be constantly changing as a response to lớn buying and selling forces.

The relation between the maturity & varying prices of the futures contracts generate different price patterns, which are commonly referred lớn as contango (1) and normal backwardation (3). These price patterns are directly related khổng lồ the expected spot price (2) of an asset at the expiration date (4), as illustrated below.



In a contango scenario, futures contracts are traded above the expected spot price, usually for convenience reasons. For instance, a futures trader may decide to pay a premium for physical commodities that will be delivered in a future date, so they don’t need to worry about paying for expenses such as storage and insurance (gold is a popular example). Additionally, companies may use futures contracts to loông chồng their future expenses on predictable values, buying commodities that are indispensable for their service (e.g., bread producer buying wheat futures contracts).

On the other hvà, a normal backwardation market takes place when futures contracts are traded below the expected spot price. Speculators buy futures contracts hoping to lớn make a profit if the price goes up as expected. For example, a futures trader may buy oil barrels contracts for $30 each today, while the expected spot price is $45 for the next year.

Closing thoughts

As a standardized type of forward contract, futures contracts are aao ước the most used tools within the financial industry & their various functionalities make them suitable for a wide range of use cases. Still, it is important khổng lồ have sầu a good understanding of the underlying mechanisms of futures contracts và their particular markets before investing funds.

While “locking” an asset’s price in the future is useful in certain circumstances, it is not always safe - especially when the contracts are traded on margin. Therefore, risk management strategies are often employed khổng lồ mitigate the inevitable risks associated with futures contracts trading. Some speculators also use technical analysis indicators along with fundamental analysis methods as a way to lớn get insights inkhổng lồ the price action of futures markets.

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