Future Contracts

Advantages of Futures Contracts

Following are the benefits of futures trading:

  1. Hedging

    Hedgers are those producers of commodity (e.g. an oil company, a farmer or a mining company) who comes to a futures exchange in order to manage the price risk of their underlying business, assets or holdings.

    For example, if the farmer thinks the cost of wheat is going to fall by the time the crop will be harvested, he will sell a futures contract in wheat. This means one can opt for a trade by selling a futures contract first and then leave the trade later by buying it. Farmers need to hedge the risk of falling crop prices whereas airlines need to hedge the risk of rising fuel costs. On the opposite side, millers need to hedge against rising crop prices as these are their main input commodities.

  2. Low Execution Cost

    To own a futures contract, an investor only has to put up a small fraction of the value of the contract (usually around 10%) as margin. The margin required to hold a futures contract is therefore small and if he has predicted the market movement correctly, he receives huge profits.

  3. Liquidity

    Because there are huge amounts of contracts traded every single day, there is a great chance for the market orders being placed very quickly. For this reason, it is uncommon for the prices to leap a jump onto a completely new level hence the trading in futures contracts are very liquid.