Economics Financial Markets Questions
Futures trading is a financial market activity that involves the buying and selling of standardized contracts, known as futures contracts, which obligate the parties involved to buy or sell a specific asset at a predetermined price and date in the future.
The process of futures trading typically involves the following steps:
1. Market participants: Futures trading involves two main types of participants - hedgers and speculators. Hedgers are individuals or businesses seeking to protect themselves against potential price fluctuations in the underlying asset, while speculators aim to profit from price movements.
2. Contract creation: A futures contract is created by an exchange, which specifies the underlying asset, contract size, delivery date, and other terms. These contracts are standardized to ensure liquidity and ease of trading.
3. Placing orders: Traders can place orders to buy or sell futures contracts through a broker or directly on an electronic trading platform. They specify the quantity, price, and expiration date of the contract.
4. Margin requirements: To trade futures, traders are required to deposit an initial margin, which is a percentage of the contract value. This serves as collateral and ensures that traders can meet their financial obligations.
5. Price discovery: Futures prices are determined through an open and transparent auction process on the exchange. Buyers and sellers submit their bids and offers, and the market price is determined based on supply and demand dynamics.
6. Execution and clearing: When a buyer and seller agree on a price, the trade is executed, and the exchange matches the two parties. The exchange acts as a central counterparty, guaranteeing the performance of the contract.
7. Marking to market: At the end of each trading day, the exchange calculates the daily settlement price based on the closing prices of the futures contracts. Profits or losses are then credited or debited to traders' accounts, a process known as marking to market.
8. Delivery or offsetting: Most futures contracts are offset before the delivery date, meaning traders close out their positions by taking an opposite position to their original trade. This allows them to profit from price movements without physically taking delivery of the underlying asset.
Overall, futures trading provides a mechanism for market participants to manage risk, speculate on price movements, and facilitate price discovery in financial markets.