Understanding The Futures Market
Originally, the stock market was created as a way for companies to
raise capital. By exchanging ownership in a company for cash, early
business ventures were able to raise capital to buy equipment or build
factories. Companies hundreds of years ago, as well as today,
primarily use the stock market as a means to raise capital.
The modern futures market evolved not from a need to raise capital,
but from a need to transfer risk. The futures market makes it possible
for those who want to manage price risk (hedgers) to transfer that risk
to those who are willing to accept it in the hopes of a profit
(speculators).
Futures markets are first and foremost a risk transference vehicle.
They also provide price information that the world looks to as a
benchmark in determining value of a particular commodity or financial
instrument on any given day or at any specific time of the day. These
benefits, risk transference and price discovery, reach every sector of
the world economy where changing market conditions create
economic risk in the diverse fields of agricultural products, foreign
exchange, imports, exports, financing, and investment vehicles.
What Are Futures?
Futures contracts are standardized to meet the specific requirements
of buyers and sellers for a variety of commodities and financial
instruments. Quantity, quality, and delivery locations are pre-
established. The only variable is price, which is discovered through an
auction-like process on the trading floor of an organized futures
exchange.
Example
An individual buys one contract of March Corn at $2.25 per bushel on
January 2nd, initiating a long position. This contract calls for the
delivery of 5,000 bushels of Number 2 Yellow Corn seven days before
the last business day of the delivery month (March) at an exchange-
recognized facility. If the purchaser of the March Corn contract wishes
to exit his position on February 15th, he can do so by selling one
March Corn contract.
Assuming that the contract was sold at $2.45 per bushel, the holder of
the March Corn contract would receive $1,000.00 (before broker
commissions and fees) for holding the position for six weeks:
Profit or Loss = Sale Price - Purchase Price x # of bushels
($2.45 - $2.25 = $0.20 x 5,000 = $1,000.00)
The person in this example is $1,000.00 richer for the experience,
and has no further obligation in the Corn market because the sale of
the March Corn futures contract at $2.45 per bushel offset the earlier
purchase at $2.25 per bushel.
Notice in the previous example that all of the features of the contract
were predetermined by the exchange, except the price:
•
Quantity: 5,000 bushels for Corn futures
•
Quality of the Corn: #2 Yellow
•
Delivery time: 7th to last business day of the contract month
•
Location: exchange-recognized warehouse or transfer station
Because futures contracts are standardized (with price as the only
variable), buyers and sellers are able to exchange one contract for
another and actually offset their obligation to deliver or take delivery
of the commodity underlying the futures contract. Offset means to
take an equal and opposite position in the futures market to one’s
initial position.
It’s Not Rocket Science..
Markets can only do three things, they can go up, they can go down, or they
can go sideways. The key to your success is knowing when markets have a
tendency to do one or the other, and then place your order to take advantage.
Futures Contracts
Futures contracts are financial
assets just like stocks and bonds,
but with some important
differences. These differences are
what make futures such an
appealing investment for traders.
Copyright © 2011, The PitMaster .com, All Rights Reserved
Understanding The Futures Market
Originally, the stock market was created as a way for companies to
raise capital. By exchanging ownership in a company for cash, early
business ventures were able to raise capital to buy equipment or build
factories. Companies hundreds of years ago, as well as today,
primarily use the stock market as a means to raise capital.
The modern futures market evolved not from a need to raise capital,
but from a need to transfer risk. The futures market makes it possible
for those who want to manage price risk (hedgers) to transfer that risk
to those who are willing to accept it in the hopes of a profit
(speculators).
Futures markets are first and foremost a risk transference vehicle.
They also provide price information that the world looks to as a
benchmark in determining value of a particular commodity or financial
instrument on any given day or at any specific time of the day. These
benefits, risk transference and price discovery, reach every sector of
the world economy where changing market conditions create
economic risk in the diverse fields of agricultural products, foreign
exchange, imports, exports, financing, and investment vehicles.
What Are Futures?
Futures contracts are standardized to meet the specific requirements
of buyers and sellers for a variety of commodities and financial
instruments. Quantity, quality, and delivery locations are pre-
established. The only variable is price, which is discovered through an
auction-like process on the trading floor of an organized futures
exchange.
Example
An individual buys one contract of March Corn at $2.25 per bushel on
January 2nd, initiating a long position. This contract calls for the
delivery of 5,000 bushels of Number 2 Yellow Corn seven days before
the last business day of the delivery month (March) at an exchange-
recognized facility. If the purchaser of the March Corn contract wishes
to exit his position on February 15th, he can do so by selling one
March Corn contract.
Assuming that the contract was sold at $2.45 per bushel, the holder of
the March Corn contract would receive $1,000.00 (before broker
commissions and fees) for holding the position for six weeks:
Profit or Loss = Sale Price - Purchase Price x # of bushels
($2.45 - $2.25 = $0.20 x 5,000 = $1,000.00)
The person in this example is $1,000.00 richer for the experience,
and has no further obligation in the Corn market because the sale of
the March Corn futures contract at $2.45 per bushel offset the earlier
purchase at $2.25 per bushel.
Notice in the previous example that all of the features of the contract
were predetermined by the exchange, except the price:
•
Quantity: 5,000 bushels for Corn futures
•
Quality of the Corn: #2 Yellow
•
Delivery time: 7th to last business day of the contract month
•
Location: exchange-recognized warehouse or transfer station
Because futures contracts are standardized (with price as the only
variable), buyers and sellers are able to exchange one contract for
another and actually offset their obligation to deliver or take delivery
of the commodity underlying the futures contract. Offset means to
take an equal and opposite position in the futures market to one’s
initial position.
It’s Not Rocket Science..
Markets can only do three things, they can go up, they can go down, or they
can go sideways. The key to your success is knowing when markets have a
tendency to do one or the other, and then place your order to take advantage.
Copyright © 2011, The PitMaster .com, All Rights Reserved
