Tag Archives: futures markets

Fundamentals: The mechanisms of the futures market

In the capital market, a trader has several options and investing opportunities in which he can foray into, depending which ones suit his needs, goals, risk profile, and personal preferences best. One of these is the futures market. Basically, buyers and sellers create and finalize agreements by entering into futures contracts. It is stated within the contract how much goods will be paid for and its date of delivery.  As The Balance defines it, a future contract is “an agreement between a buyer and seller of the contract that some asset—such as a commodity, currency or index—will be bought or sold for a specific price and quantity, on a specific day, in the future (expiration date).”

 

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Image source: marketbusinessnews.com

 

As an example, let’s consider Ben and Marcus. Ben is a fisherman while Marcus is a fish vendor. They have entered into a contract wherein Ben has to sell Marcus 100 tunas at $1 per head for the next fishing season. Ben is trying to secure a future selling price, while Marcus on the other hand is trying to establish a fixed buying price. If the price of tuna increases to $2 the next day, then Marcus would have profited since the buying price is already fixed. Ben on the other hand would have incurred a loss since he can’t sell his products at the adjusted market price. These fluctuations are then calculated and monitored daily until an agreed upon date. If the next fishing season arrives and the price of the commodities hasn’t changed, then Ben would have lost $100 while Marcus would have made $100.

 

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Image source: entrepreneur.com

 

One economic importance of the futures market is price discovery. Because of its highly competitive nature, it becomes an important factor in determining the prices based on the present and future estimated supply and demand. It is also important in reducing risks when making purchases since the buying price can’t be changed even if the market price has increased (or decreased) significantly. Prices are fixed however the market moves.

 

To know more about futures contracts, trading, or the investment industry in general, consult with any of LOM Financial’s investment advisors.