Understanding Futures Contract in Stock Market
As the name suggests, ‘future contracts’ are those legal agreements done on the basis of per-decided future trades in which two parties mutually agree to either buy or to sell an instrument related to the finance or some other kind of commodity at an already fixed price on the decided date and time in the future. Thus, on the basis of the future contracts, there lies a future exchange, on which trading of the futures contracts is being done by having a dependency on the assets that are already underlying, and the details of the quantity and quality of the commodity being shared.
Let us understand future contracts by a very simple example. There are two most popular types of market players being involved in this: first are the speculators and the second one are the hedgers. Here, speculators are the ones who are the traders or portfolio managers of the commodity or the financial asset being traded and the hedgers are the producers or the purchasers of the commodity or the financial asset. The commodities can be the very another commodity that is being produced all over the world such as metals of various types, gas, energy products, agricultural products, etc.
Numerous types of assets are being traded as futures contracts in different stock market indices all over the world. It would be interesting for you to know that even the major stock and currencies across the world trade their future contracts.
Let us suppose there is an oil supplier, who has the oil sufficient for being able to trade for the coming year and more, so he decides to ensure his sale of oil in the coming time and therefore, enters into a futures contract in which the price of selling is fixed for a sale after 365 days and that he shall not face any problem in the supply of the oil that he has stocked with him. The futures contract price is decided by keeping in knowledge multiple factors. These factors are the current market price of the commodity, the expected rate of return without any risk, the period of maturity, cost of storing the commodity, and the cost of convenience are being calculated mathematically, after which the price of futures contract is decided. In this case, you must have observed that the supplier has ensured his deal, and will be able to maintain the business in the coming time as well.
The above illustration showed us the future contracting of commodity products but there are non commodity future contracts also being done in the capital market. Mostly, these future contracts are brought under the indices to being able to trade and promoted under a safe exchange.
As every commodity selling in the market has its expiry date the same way the future contracts have their own expiration. So, it is one of the important factors for an investor or a trader to be aware of the expiry of the contract in advance.