Economics Options And Futures Questions
Options and futures help in managing price risk by providing individuals and businesses with the ability to hedge against potential price fluctuations.
Options allow the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price (strike price) within a specified time period. By purchasing options, individuals can protect themselves against potential price increases or decreases. For example, if a farmer expects the price of corn to decrease, they can purchase a put option, which gives them the right to sell corn at a predetermined price. If the price does indeed decrease, the farmer can exercise the option and sell their corn at the higher strike price, thus mitigating their losses.
Futures contracts, on the other hand, obligate the buyer and seller to transact the underlying asset at a predetermined price and date in the future. By entering into a futures contract, individuals can lock in a price for the asset, thereby eliminating the uncertainty associated with future price movements. For instance, a company that needs to purchase oil in the future can enter into a futures contract to buy oil at a specific price, ensuring that they are protected against potential price increases.
In summary, options and futures provide individuals and businesses with the means to hedge against price risk by allowing them to protect themselves against potential price fluctuations and lock in prices for future transactions.