What are the Advantages and Risks of Futures Transactions?
Futures transactions are contracts made between buyers and sellers in forward markets. In these contracts, a certain amount of a certain asset is agreed to be delivered at a certain price on a certain date. What are the advantages and risks of futures transactions? In this article, we will try to explain the basic features, advantages and risks of futures transactions for you.
Advantages of Futures Transactions
The most important advantage of futures transactions is that they provide protection against price fluctuations. For example, if a cotton producer is worried that the price of cotton will decrease at harvest time, he can fix the future price by entering into a contract to sell cotton in the futures market. Thus, even if the price of cotton falls, it can compensate for its loss with the profit it will make from the futures contract.
Futures transactions are also an attractive option for those who want to invest for speculative purposes. In futures markets, thanks to the leverage effect, it is possible to take a large position with a low collateral. This offers a high profit opportunity. However, leverage also carries equally high risks. Therefore, when making futures transactions, it is necessary to follow market movements well and manage risk.
Futures transactions also provide arbitrage opportunities. Arbitrage is the process of making risk-free profits by taking advantage of price differences for the same asset in different markets or different maturities. For example, if the price of an ounce of gold in the spot market is 1800 dollars, and the price of a 6-month gold contract in the futures market is 1850 dollars, the arbitrageur can guarantee a profit of 50 dollars by buying gold in the spot market and making a sales contract in the futures market.
Risks of Futures Transactions
The biggest risk of futures transactions is that large losses may occur if the market moves contrary to expectations. For example, let's say an investor makes a purchase contract in the futures market, thinking that the price of gold will rise. However, let the price of gold start to fall. In this case, the investor's loss may be unlimited. Because, in accordance with the futures contract, the gold must be delivered at the end of the maturity. Therefore, it is important to place a stop-loss order when trading futures.
Another risk that should be considered when making futures transactions is liquidity risk. Liquidity risk is the situation where it becomes difficult or impossible to dispose of the futures contract before its maturity. For example, let's say an investor makes an oil purchase contract in the futures market. However, he wants to close his position because the price of oil has fallen. However, there may not be enough demand in the market to make an oil sales contract. In this case, the investor may have to realize his loss.
Another risk that may be encountered when performing futures transactions is the risk of default. Default risk is the situation where one of the parties to a futures contract does not fulfill the contract terms. For example, let's say an investor has made a wheat sales contract in the futures market. However, he may not be able to deliver the wheat when the maturity comes. In this case, the buyer may be harmed.
How to Transact Futures?
Investors who want to trade futures must first choose a brokerage firm and open an investment account. The brokerage firm provides the investor with access to the futures market and executes his transactions. The brokerage firm also monitors the investor's collateral and makes a margin call when necessary.
There are some points that investors should pay attention to when making futures transactions. These:
- To know the features of the futures contract well. Futures contracts are standardized contracts and each contract has characteristics such as underlying asset, quantity, price, maturity and delivery method. These characteristics may be different for each asset traded in the futures market. For example, the underlying asset of a gold futures contract is 1 ounce of gold and its maturity is 3 months. The underlying asset of the wheat futures contract is 5 tons of wheat and its maturity is 6 months.
- To follow the factors affecting the prices of assets traded in the futures market. The prices of assets traded in the futures market are determined according to the balance of supply and demand. Factors affecting supply and demand vary depending on the type of asset. For example, factors such as global economic developments, political events, production costs and stock availability affect the price of oil. Factors such as inflation, interest rates, geopolitical risks and exchange rates affect the price of gold.
- Determining trading strategy in the futures market. An investor who wants to trade in the futures market must determine a trading strategy that suits his or her risk profile, expectations and goals. Trading strategy involves decisions such as which asset the investor will enter, in which direction (buy or sell), with how much, and when to enter and exit. When determining a trading strategy, it is important to conduct market analysis, use technical and fundamental indicators, and perform risk management.
Final Word on Futures Trading
Futur ES transactions are contracts made in forward markets. The advantages of futures transactions include protection against price fluctuations, speculative profits and arbitrage opportunities. Risks of futures transactions include movement contrary to market expectations, lack of liquidity and default risk. Investors who want to make futures transactions must know the features of futures contracts well and follow market movements.