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What is a futures contract?

what is futures contract
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Futures contracts allow buyers and sellers to agree on a price today for a transaction that will occur at a future date. Crypto traders worldwide use futures contracts to hedge against future price fluctuations or for speculative investment purposes.

Therefore, futures contracts provide a way for businesses and traders to mitigate risks related to price volatility in commodities and financial assets. Let's take a deeper look at what futures contracts are, how they work, and much more in our comprehensive guide!

How do futures contracts work?

Futures contracts are legally binding agreements between a buyer and seller to exchange an asset at a predetermined future price. The underlying asset can be agricultural goods, metals, currencies, stock indexes, and more.

For a futures contract example, an airline company may enter into a futures contract to lock in the price of jet fuel for delivery in six months. This allows them to budget fuel costs with more certainty.

Speculators also trade futures contracts, hoping to profit from anticipated price movements. Both parties to a futures contract must post an initial deposit, or margin, to cover potential losses.

Traders credit or debit realized gains and losses from their accounts daily by marking open positions on the market. This limits counterparty risk.

What are the advantages and disadvantages of futures contracts?

Futures contracts provide several advantages for hedgers seeking price protection. One key benefit is that futures prices closely track the underlying cash market, allowing participants to hedge at minimal cost.

Contracts trade virtually around the clock, contributing to high liquidity. Futures, however, carry inherent risks, such as the need to maintain an adequate margin for daily mark-to-market settlements, or else the position will be liquidated.

Leveraged trading also magnifies both gains and losses. Timing the market is challenging, and unexpected events can move prices against open positions.

What is the main purpose of futures contracts?

The main purpose of futures contracts is to mitigate risk arising from fluctuating prices. Hedgers seeking to offset future price exposure in their core businesses place around 85% of futures trades worldwide.

This allows commercial participants like farmers, miners, and manufacturers to lock in input costs or sales prices. Speculators also trade futures to profit from anticipated market moves. Their trading activity provides liquidity to hedgers while also helping incorporate new information into prices.

futures contract

What are the four types of futures contracts?

There are four main types of futures contracts, each differentiated by the nature of the underlying asset.

Here are the types:

Commodity futures

Contracts based on physical commodities like agricultural goods, metals, and energy products.

Financial futures

Futures on stock indexes, government bonds, currencies, and cryptocurrencies.

Stock index futures

Stock market benchmark indexes like the S&P 500 or FTSE 100 peg contracts.

Crypto futures

Recently introduced futures contracts for digital assets like EURK, which is a securely audited stablecoin that has reserves in Switzerland and the Dominican Republic, offering transparent transactions that are fast and secure.

According to IMF data, developing economies in Sub-Saharan Africa and South Asia account for over 30% of the global population without access to traditional bank accounts. EURK euro stablecoin can help bridge this gap by facilitating low-cost financial services for the underbanked.

What is the difference between a contract and a futures contract?

The key difference between a contract and a futures contract is standardization. Ordinary contracts are customized agreements negotiated between specific counterparties.

Futures contracts, on the other hand, are highly standardized with strict rules issued by regulated exchanges. Predefined contract terms include quantity, quality, delivery date, and place, leaving no room for variation.

Before expiration, market participants can readily offset or assign fungible contracts. Standardization improves liquidity, transparency, and price discovery compared to over-the-counter deals.

What is a futures contract an example of?

Crypto derivatives, such as futures contracts, link the value of a financial instrument to an underlying asset. Rather than owning the asset outright, derivatives allow participation through agreements established now but settled in the future.

Other common derivatives include options, swaps, warrants, and forwards. All are contracts representing claims on the underlying without requiring physical delivery. You can check out “Perpetual Swap Contract” for more details.

They include future agreements to buy or sell something at an arranged price, allowing speculation or hedging separate from owning the actual asset. This is especially important for the crypto market for crypto investments, crypto trading, and crypto payments.

Is a futures contract a hedge?

Yes, using futures contracts as a hedge is one of their primary applications. A hedge involves establishing positions that offset price-risk exposures from core business activities or investments.

For example, an apple farmer could sell apple futures now at a set price to protect against low market prices later, when the crop is harvested.

Entering equal but opposite long and short futures positions achieves this risk mitigation. Gains in the futures market will offset losses from the physical crop if apple prices drop.

This allows producers and consumers to operate with more predictable budgets and profit margins despite fluctuating commodity values. So futures hedging provides a powerful tool for businesses managing commodity price risk. The same is true for cryptocurrencies, too.

futures contracts

How are futures contracts priced?

Crypto traders on the crypto exchange price futures based on the expected future value of the underlying asset on the expiration date, discounted for interest rates. The primary drivers are supply and demand amongst traders on the exchange.

When interest rates rise, investors lower futures prices below the anticipated spot price to compensate for the time value of money being tied up. Additionally, futures in finance reflect factors like the cost of carrying and the expenses of holding, insuring, and financing inventory.

Contracts also incorporate the effect of dividends or the forward price differential between cash and futures markets. Ultimately, daily trading dictates the equilibrium price where buyers and sellers are equally willing to transact.

Who issues futures contracts?

Futures contracts are standardized legal agreements issued and governed by regulated futures exchanges rather than private counterparties.

Exchanges handle daily trading, clearing, and settlement between members. They carefully design each contract to ensure sufficient liquidity for offsetting positions easily.

Furthermore, exchanges enforce margin and collateral rules to minimize default risk. This centralized model increases transparency and creditworthiness versus over-the-counter bilateral dealings.

The bottom line

Futures contracts provide an important tool for hedging financial risks and facilitating price discovery across global commodity and capital markets. As we have explored, futures allow businesses and traders to offset price exposure through binding agreements established today for future delivery.

The benefits and standardized structure of futures contracts have made them a cornerstone of modern commerce worldwide. A stablecoin like EURK also supports financial inclusion through low-cost cross-border payments and international payments. You can also use EURK for e-commerce payments.

As the best stablecoin for the euro in the stablecoin ecosystem, EURK provides stability of stablecoin, transparency for stablecoin, and stablecoin liquidity. These features make it a secure stablecoin, and therefore, it is favored by many crypto investors worldwide.

If you want to explore the secure euro stablecoin platform advantages with EURK, become a partner today and grow your individual and business projects with the power of the euro coin. The future awaits you; don’t wait up!

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Digital assets are subject to a number of risks, including price volatility. Transacting in digital assets could result in significant losses and may not be suitable for some consumers. Digital asset markets and exchanges are not regulated with the same controls or customer protections available with other forms of financial products and are subject to an evolving regulatory environment.

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