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Futures - in simple words

Futures - in simple words

Often the concept of futures misleads some traders about the available financial instruments in stock trading - stocks, indices, crypts, etc.

If with stocks, indices or with the same crypt, the very meaning of a trade transaction is simple and clear - bought for one price and sold for another , then with futures, some have difficulties in understanding this financial instrument.

Futures are purely a speculative trading instrument (not an investment), which can be safely equated to "a bet"between a buyer and a seller. In simple words, this is a contract for the sale of the underlying asset today, but with delivery on the date of execution of the contract.

That is, the buyer of the futures pays for the goods (the underlying asset) at the current price at the time of the transaction (specified in this futures contract), and when the seller already delivers this product to him (at the time of execution of the contract), the buyer is already taking into account the market price (valid in this moment) on this asset will receive either a profit, or a loss. If the price is higher than the one he paid, then the buyer will be in the black and the seller in the red, and vice versa - if the price is lower, the buyer will be in the red and the seller in the black.

A futures seller is someone who guarantees that he will deliver a certain asset at a certain time at the price specified in the contract, regardless of what it will be on the market.

The buyer of the futures is the one who will pay the contract at the value specified in it and take the asset to his balance at the time of execution of the contract, if the contract is deliverable. If the contract is settlement, then the exchange will simply recalculate the value of the transaction on the date of its execution.

On the stock exchange, when buying futures, the buyer simply selects the terms of the transaction of a certain seller in the terminal, which usually indicate:

  • type of contract (delivery or settlement)
  • asset volume (lot)
  • collateral (if there are not enough own funds, the exchange can provide leverage for the purchase of lots or other volumes),
  • contract price (futures purchase)
  • date of execution of the contract (when the full settlement of obligations takes place)

The exchange is responsible for all other details of the contract – commission, fines, etc.

To participate in the transaction, it is enough to simply buy or sell futures through the broker's application of its trading terminal.

The futures buyer undertakes to buy the underlying asset from the seller on a certain day, and the futures seller undertakes to deliver it on the day of execution of this contract.

Most futures on the exchange are not delivered, but calculated.

In the case of a delivery futures, the seller delivers (transfers) to the buyer at the time of execution of the contract a real asset (shares). The buyer, in this case, if the current market price of this asset is lower than the one he will already pay to the seller, then in order not to incur losses, he can wait for a certain period for their profitable sale on the exchange. With a settlement futures, it will not be possible to wait, the exchange will automatically calculate the transaction and update the cash balance on the buyer's account.

Let's give a simple example of how a futures transaction occurs on the stock exchange, and evaluate its result from the position of the buyer and seller.

On the stock exchange in December 2021, a futures for the sale of shares of a certain company was put up:

  • contract type – settlement
  • asset volume - 1 lot (10 shares)
  • collateral - 100% (without leverage).
  • contract price 10000 rubles. (10 shares x 1000 rubles)
  • execution date – the first trading day of the month of execution (December 2022)

futures - in simple words

A year after the purchase of the futures, the exchange recalculates the balances on the accounts of the participants of the transaction, taking into account the current market price for the underlying asset (share).

That is, since the price per share of this company has increased by 150 rubles (from 1 000 rubles to 1 150 rubles) by the time the futures are executed, the buyer's balance sheet will already be 11 500 rubles, including profit (+) 1 500 rubles.. The balance of funds on the seller's balance sheet will decrease by the amount of his loss (-) 1 500 rubles.

This is the principle by which a futures transaction is implemented on the stock exchange.

One of the important patterns of a futures transaction !

As the contract execution date approaches, the futures price always approaches the price of the underlying asset and is eventually compared with it.

And this, of course. Because if, for example, the contract execution period was 1-2 days, then a significant deviation of today's price from tomorrow's price for the underlying asset would completely deprive the meaning of trading this speculative instrument (everyone would buy assets today, knowing what the price will be tomorrow, or vice versa, sell).

Earning with this tool is based on the need to predict the price over a long period of time. That is why in futures trading, the market itself finds the effective price of the contract, which, when its execution date approaches, approaches the price of the underlying asset.

Often in the news feed you have to see such headlines as – «Gold and WTI oil futures fell in price during Asian trading ».

futures - in simple words - 1

This suggests that there are fundamental prerequisites for the fact that the price of these underlying assets will fall in the near future. Due to this kind of news, the market is trying to equate futures prices with the market price of the near future, because the probability of the market entering such a price level has increased.

That is, earnings on futures are based on the principles of "divination" in conditions of low market predictability, and not vice versa. Therefore, futures are speculation and big risk, especially when trading is carried out using leverage.

Futures - in simple words - Something like that!

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