Analysis: what are futures and how to use them for exchange investments
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In our blog we write a lot about the structure of modern exchanges and emerging new investment tools, such as structured products , model portfolios or ETFs . But proven instruments, such as futures and options, are also very popular.
We will talk about futures in today's article: how did this financial instrument appear, why is it needed, and how does it work on modern exchanges.
Note : any investment activity on the exchange is associated with a certain risk, this must be taken into account. To carry out operations with the assets referred to in this topic, you need a brokerage account, you can open it online . You can debug your trading strategy using test access with virtual money .
How did futures come about?
The idea to conclude contracts for the supply of some goods in the future at a certain price, negotiated now, seemed a fairly obvious way to minimize risks hundreds of years ago. Therefore, they concluded similar deals in different countries.
The first exchange on which futures were traded, and the existence of which was documented, was founded in 1710 in Japan - these were futures on fig.
Engraving depicting bidding at the rice exchange in Japan
In the West, futures in one form or another were also traded in the Middle Ages, but the first official exchange appeared in London in 1877 - it was called the London Metals and Market Exchange.
In the United States, the first trading platform for the use of futures appeared in 1848, and it was called the Chicago Board of Trade (CBOT). It mainly sold grain or livestock - farmers from the Midwest came to Chicago and sold their goods to dealers.
The whole process was fraught with a lot of risks - it was not easy to transport goods, especially in winter, they often spoiled. In addition, unpredictable demand situations arose because of the long journey - once in the city there were not so many farmers selling grain and cattle, and sometimes there was an influx of sellers, and prices fell sharply.
Futures helped solve these problems. The scheme could be as follows: a farmer sells grain to a merchant in late autumn or early winter, which he must store until it can be transported, for example, along the river. At the same time, no one canceled the risk of falling prices for the winter. To protect themselves from this, merchants who bought grain went to Chicago and concluded contracts with grain processors there in the spring. Thus, they guaranteed themselves both buyers and an acceptable price for grain.
How futures work now
Today, a futures contract is an obligation to buy or sell a specific asset (it is called the underlying) at a certain price on a certain date in the future. In addition, each futures contract is characterized by the amount of the underlying asset (e.g. shares), the date the contract is executed (expiration date) and, in fact, the price (strike price) at which the buyer agrees to buy the underlying asset and the owner to sell.
Thus, the seller is obligated to sell a certain amount of the underlying asset in the future at a certain price, and the buyer, after this time, buy it at an agreed price. The guarantee of the transaction is the exchange, which takes insurance deposits from both parties to the transaction.
The underlying asset may be:
- A certain number of shares (stock futures);
- Stock Indices (Index Futures);
- Currency (currency futures);
- Commodities traded on exchanges, such as oil (commodity futures).
- Interest rates (interest-bearing futures).
Trades in futures contracts are held on exchanges in the corresponding derivatives sections. For example, the derivatives market is also on the Moscow Exchange . To buy or sell futures, an investor will need a brokerage account and a trading terminal .
There are two types of futures - settlement and delivery. As the name of the latter, it is clear, in this case, when the expiration date of the contract, the delivery of the underlying asset (for example, currency or goods such as oil).
If such a delivery is not implied, then we are dealing with settlement futures. In this case, at the time of its expiration, the parties to the transaction get the difference between the price of concluding the contract and the estimated price on the expiration day, multiplied by the number of contracts available. Index futures are just calculated ones, since they cannot be put.
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