What are Futures? The name says it all: Futures are transactions whose fulfillment lies in the future. Both commodities and securities can be traded, sometimes even futures on fictitious securities are offered, such as the Bitcoin Future. In contrast to options, futures are an unconditional forward transaction, so there is no option right, but the purchase or sale takes place in any case.
What are Futures – Explanation in Key Points
- Fulfillment in the future
- commodities (which Bitcoin is in the USA) or securities tradable
- Difference and delivery transactions
- Very speculative
The Idea behind Forward Contracts
The future is uncertain and that is often a problem. For example, when airlines are already selling August tickets in January, but don’t yet know what prices they will have to pay for kerosene. Or when companies enter into long-term supply contracts at fixed prices without knowing what the raw materials will cost them in the future.
Futures are therefore a kind of insurance. Of course Lufthansa could already buy and store the fuel for the whole year today, but that would cause high storage costs. In the case of food, storage is only possible to a limited extent, and it works even worse in the case of electricity. The most important commodity futures exchange in Germany is therefore also the Energy Exchange in Leipzig, which primarily trades electricity.
Meanwhile, the idea has also been transferred to securities, even cheap shares can be traded online via Future. One of the best known examples of this is the Bitcoin Future. This is a futures contract with a nine-month term at the start of a fictitious federal bond with a term of ten years and an interest coupon of 6.0 percent.
Originally, futures contracts were mainly concluded for commodities, but today there are also numerous futures contracts on securities.
What information must a Futures Contract contain?
Each future is issued on a specific underlying asset, such as the DAX. The value ratio of the future to the underlying asset or the value of a point in the future must also be specified. With the USD BUND Future, a contract is concluded for bonds with a value of EUR 100,000. With the DAX Future (FDAX), each point is worth 25 USD. At the same time, the smallest change in value (tick) is also defined, the FDAX, for example, always moves in steps of half points, so it can rise from 2,022.5 points to 2,023.0 points, but not to 2,022.7.
In addition, of course, a maturity must be specified; the BTC Future, for example, runs for a maximum of nine months. In addition, the amount of the margin and the costs must be defined.
In addition to the underlying asset, information on the value, the term and the margin are particularly important.
Bitcoin margin trading gets well explained on The Margin.
What is an Unconditional Forward Contracts?
There are two types of forward transactions: conditional and unconditional. In the case of conditional forward transactions, a participant has the right, but not the obligation, to execute the trade. Such conditional forward transactions are options, in which the holder also has the option not to exercise the option. For example, anyone who has the right to buy a security at a price of 6.80 USD will not use it if the current price is only 6.40 USD, i.e. the option is out of the money.
The situation is different with a future, where trading takes place in any case. The holder of an option must pay twice for this, once for the option and also for the security or the commodity. In the case of a future, the option price is often replaced by a down payment, the margin. This, however, is later offset against the purchase price, in contrast to the price for the option.
What are futures? Futures are unconditional forward transactions, so trading always takes place. Options, on the other hand, are conditional forward transactions; the owner of an option can also waive his option right.
What is a Difference Contract?
If you trade futures for speculative reasons, you naturally do not want 100 tonnes of coffee delivered at the end of the term. Such delivery transactions are common when companies want to hedge against price fluctuations on the futures markets, for example when a coffee roasting company buys coffee beans for the future.
Anyone trading for speculative reasons is usually not interested in a delivery transaction. Difference transactions are therefore common, especially for futures on securities and indices. The difference between the market price and the agreed price is taken into account, from which profit and loss are calculated.
If the buyer of a futures suffers a loss, the margin is initially used to service the loss and the remaining money is returned. If the loss exceeds the security deposit, money must be replenished. In contrast to options, more money can be lost than the money initially paid. If the current value is higher than the purchase price, the buyer receives the difference and the margin is paid back, less the fees, of course.
Also read this article about margin trading in the field of cryptocurrency at cointelegraph.com in order to even better understand the concept.