Futures how does it work

Forwards, in contrast, trade over the counter OTC with terms and contract specifications customized by the two parties involved. Unless the contract position is closed out prior to its expiration, the short is obligated to make delivery to the long, who is obligated to take it. Depending on the contract, the values exchanged can be settled in cash. Most often, the trader will simply pay or receive a cash settlement depending on whether the underlying asset increased or decreased during the investment holding period.

In some cases, however, futures contracts will require physical delivery. In this scenario, the investor holding the contract upon expiration would be responsible for storing the goods and would need to cover costs for material handling, physical storage, and insurance.

Speculators can use futures contracts to bet on the future price of some asset or security. Hedgers use futures to lock in a price today to reduce market uncertainty between now and the time that good is to be delivered or received. Arbitrageurs trade futures contracts in or across related markets, taking advantage of theoretical mispricings that may exist temporarily.

Depending on your broker and your account status with that broker, you may be eligible to trade futures. You will require a margin account and be approved to do so. Qualified traders in the U.

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Your Money. Personal Finance. Your Practice. Popular Courses. Part Of. Introduction to Futures. Overview of Futures Products. How to Trade Futures. Futures Trading Considerations. Table of Contents Expand. Although these twin stock derivatives share some commonalities, they are also markedly different in certain key respects. Both derive their value from an asset known as the underlying such as shares, commodities, exchange traded funds ETFs , share market indices, and others.

Both represent a future trade. Right vs. Obligation: Futures represent a commitment to trade that must be squared off at the specified date. Whereas options give the buyer the right, but not the obligation, to exercise the contract. Date of trade: A futures holder must trade the security at the agreed-upon date. There are some nuances around exercising options for indices versus stocks as well as different rules in different markets.

For example, in India, an index option can only be exercised on the expiration date but a stock option can be exercised anytime till the expiration date. Advance payments: There are no upfront costs when entering into a futures contract.

You make the payment only when squaring off the futures contract on the specified date. INR 20, in this example. To execute this contract, you have to keep INR 20, with your broker. The flip side, of course, is that the same logic applies to your losses. Further, if your losses deepen, you may be required to post additional margin. To buy an option, on the other hand, you will need to pay a premium. The seller of the option earns this premium as should you choose not to exercise the option, you will lose the premium paid.

Risk: In case of a price drop, you can opt out of exercising your options. Hence, options theoretically reduce the risk of loss. So, options traders are more likely than not to end up losing their premium. A call option allows you to buy the underlying asset at an agreed-upon price at a specific date. A put option allows you to sell the asset at a specified price on a specific date. In both cases, the trade is always optional. You can choose not to utilize your call or put option if the prices do not suit you.

Futures and options trading requires an understanding of the nuances of the stock market and a commitment to track the market. There is also a strong element of speculation. Hence, it is most often used by hedgers or speculators.

Futures and options trades do not need a demat account but only need a brokerage account. The preferred route is to open an account with a broker who will trade on your behalf.

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Learn how the major players in the futures market—producers, hedgers, and speculators—buy and sell futures contracts in an attempt to secure optimal prices. A futures contract is a legally binding agreement to buy or sell a standardized asset at a predetermined price at a specified time in the future. Futures contracts are traded electronically on exchanges such as CME Group, which is the largest futures exchange in the United States. What futures markets do over the short and long term can tell investors a lot about what's going on in the world how much it will cost to fill your gas tank before your summer road trip, for example.

Understanding how futures markets work, and perhaps even trading futures at some point, starts with some basic questions.