"A method of buying and selling in markets based on predefined rules used to make trading decisions."
"The main advantage for investors looking to participate in a futures contract is that it removes the uncertainty about the future price of a commodity, security, or a financial instrument. By locking in a price for which you are guaranteed to be able to buy or sell a particular asset, companies are able to eliminate the risk of any unexpected expenses or losses.”
“A futures contract is a standardized, legal agreement to buy or sell an asset at a predetermined price, and at a specified time in the future. At this specified date, the buyer must purchase the asset and the seller must sell the underlying asset at the agreed-upon price, regardless of the current market price at the expiration date of the contract. Futures contracts allow corporations (especially corporations that are producers and/or consumers of commodities) and investors to hedge against unfavorable price movements of the underlying assets.”
"Assume that the current spot price of soybeans is $10 per unit. After considering costs and expected profits, the farmer wants the minimum sale price to be $10.10 per unit, once his crop is ready. Assume also a futures contract on one unit of soybean with six months to expiry is available today for $10.10. The farmer can sell this futures contract to gain the required protection by locking in the sale price in the future. We have 3 possible scenarios:
- The price of soybeans rises up to $13 in six months. The farmer will incur a loss of $2.90 (i.e. sell price - buy price = $10.10 - $13.00) on the futures contract. He will be able to sell his actual crop produce at the market rate of $13, which will lead to a net sale price of $13 - $2.90 = $10.10
- If the price of soybeans remains at $10, the farmer will benefit from the futures contract ($10.10 - $10 = $0.10). He will sell his soybeans at $10, leaving his net sale price at $10 + $0.10 = $10.10;
- If the price declines to $7.50, the farmer will benefit from the futures contract ($10.10 - $7.50 = $2.60). He will sell his crop produce at $7.50, making his net sale price $10.10 ($7.50 + $2.60).”
"A soybean oil manufacturer who needs one unit of soybean in six months’ time. He is worried that soybean prices may increase in the near future. He can buy (go long) the same soybean futures contract to lock the buy price at his desired level of $10.10.
- If the price of soybean shoots up to say $13, the futures buyer will profit by $2.90 (buy price = $13 - $10.10) on the futures contract. He will buy the required soybean at the market price of $13, which will lead to a net buy price of -$13 + $2.90 = -$10.10 (i.e. negative indicates net outflow for buying);
- If the price of soybean shoots up to say $13, the futures buyer will profit by $2.90 (buy price = $13 - $10.10) on the futures contract. He will buy the required soybean at the market price of $13, which will lead to a net buy price of -$13 + $2.90 = -$10.10 (i.e. negative indicates net outflow for buying);If the price of soybeans remains at $10, the buyer will lose on the futures contract ($10 - $10.10 = -$0.10). He will buy the required soybean at $10, taking his net buy price to -$10 - $0.10 = -$10.10;
- If the price declines to $7.50, the buyer will lose on the futures contract ($7.50 - $10.10 = -$2.60). He will buy required soybean at the market price of $7.50, taking his net buy price to -$7.50 - $2.60 = -$10.10.”
"Rolling futures contracts refers to extending the expiration or maturity of a position forward by closing the initial contract and opening a new longer-term contract for the same underlying asset at the then-current market price. A roll enables a trader to maintain the same risk position beyond the initial expiration of the contract, since futures contracts have finite expiration dates. It is usually carried out shortly before expiration of the initial contract and requires that the gain or loss on the original contract be settled.”
"Suppose you are the owner of a network of gold mines. Your company holds substantial amounts of gold in inventory, which you eventually sell to generate revenue. As such, your company’s profitability is directly tied to the price of gold. In accordance with your estimate your company can maintain profitability as long as the spot price of gold does not dip below $1'300.00 per ounce. The actual spot price is hovering around $1'500.00 but you have seen large swings in gold prices in the last periods and are eager to hedge the risk that prices decline in the future. To accomplish this, you set out to sell a series of gold futures contracts sufficient to cover your existing inventory of gold in addition to your next year’s production. However, you are unable to find the gold futures contracts you need and are therefore forced to initiate a cross hedge position by selling futures contracts in platinum, which is highly correlated with gold. To create the cross hedge position, you sell a quantity of platinum futures contracts sufficient to match the value of the gold you are trying to hedge against. As the seller of the platinum futures contracts, you are committing to deliver a specified amount of platinum at the date when the contract matures. In exchange, you will receive a specified amount of money on that same maturity date. The amount of money you will receive from your platinum contracts is roughly equal to the current value of your gold holdings. Therefore, as long as gold prices continue to be strongly correlated with platinum, you are effectively locking in today's price of gold, protecting your margin. However, in adopting a cross hedge position, you are accepting the risk that gold and platinum prices might diverge before the maturity date of your contracts. If this happens, you will be forced to buy platinum at a higher price than you anticipated in order to fulfill your contracts."
"Suppose that Microsoft shares are trading at $108.00 per share. You own 100 shares of the stock and want to generate an income above and beyond the stock's dividend. You also believe that shares are unlikely to rise above $115.00 per share over the next month. You take a look at the call options for the following month and see that there is a $115.00 Call option trading at $0.37 per contract. So, you sell one call option and collect the $37.00 premium ($0.37 x 100 shares), representing a roughly four percent annualised income.If the stock rises above $115.00, the option buyer will exercise the option and you will have to deliver the 100 shares of stock at $115.00 per share. You still generated a profit of $7.00 per share, but you will have missed out on any upside above $115.00. If the stock does not rise above $115.00, you keep the shares and the $37.00 in premium income."