Lesson 1: What are Futures？ – OKEX OPERATING GUIDE
In the traditional derivatives market, futures are financial derivative contracts that obligate the parties involved to transact an asset at a predetermined date and price in the future. Here, the buyer must purchase, or the seller must sell the underlying asset at the agreed price, regardless of the current market price on the contract expiration date.
Traders can long or short an asset to profit from the price movement of the underlying asset, to hedge risks, or to generate stable profits by using arbitrage strategies.
Trading futures is not as difficult as it seems. Let’s look at the below examples to understand how futures work.
A gold miner mines 10 ounces of gold per year. However, as the price of gold moves up and down greatly, sometimes he can make huge profits when the gold sells for USD3,000 per ounce, but there are also times when it just sells for USD1,000 per ounce.
At the same time, the fluctuating price affects gold merchants too — they may make a lot less money when the gold price is high (because of a higher cost).
Market volatility affects traders’ income. So, is there a way to help them maximize profits?
The Emergence of Futures
The gold merchant agrees to buy 10 ounces of gold at USD2,000 per ounce from the miner after three months (USD20,000 for 10 ounces).
When the time comes, the gold price drops to USD 1,000 per ounce and 10 ounces of gold now only costs USD10,000, the gold merchant therefore backs out of the deal.
To make sure the merchant adheres to the contract, both parties agreed to pay a certain amount of deposit called margin when they signed the contract, which is kept by a third party. If either party breaks the contract, the other party can take all the margin. Therefore, the merchant and the miner signed the contract and each paid 10% of the total value (i.e. USD2,000) as margin.
What is Futures Margin
When the merchant and the miner agree to buy 10 ounces of gold at USD 2,000 per ounce after three months, they each paid 10% of the total amount (i.e. USD 2,000) as margin.
After three months, the gold price rises to USD 3,000 per ounce and 10 ounces of gold now cost USD 30,000.
The miner wants to back out of the deal this time as he could have made USD 1,000 more for each ounce, and the margin was only USD 2,000 — he can still make USD 8,000 more after the margin is forfeited.
The margin system alone cannot stop the breaching of contracts. How can traders be protected from losses? If they want to transfer the contract, can it still be traded? Or, is it too troublesome to trade actual goods, can we trade contracts instead?
This is when daily settlement, standardized futures, and exchanges come into play.
We will explain more in next lesson.
Published at Tue, 18 Feb 2020 09:21:30 +0000
