Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
So what are futures? Futures are binding contracts between the sellers and the buyers creating an obligation for the seller to deliver a certain amount of goods at a certain time and at a fixed price (per contract) to the buyer. The buyer of the contract, on the other hand, is paying the contract price to receive the goods at that time. The price of the contract is determined using competitive bidding at the exchange, which is arrived at by the traders through a process known as price discovery. Through this process buyers compete with each other to make bids for the contracts while sellers compete with each other to ask for a price. These are known as ask and bid prices. Once a buyer and seller reach an agreement on price, the contract is traded and that price becomes the going price of that contract at that moment. Contract prices move higher and lower purely based on the trader's judgment as to how much a certain commodity would be worth at the time of the delivery based on the all available data (price discovery). As you may imagine, supply and demand play a big role in determining a contract's price, but perception is also a big factor in all this. If for example, a certain commodity, such as gold, is perceived as likely to be in short supply in six months, the futures contracts for gold with a six-month maturity will rise in price. And if a warm winter is predicted, the heating oil contracts maturing in winter months may see their prices diminished.
Why would people want to engage in trading futures? Let's take a look at a practical example. Airlines by nature require a great amount of jet fuel to stay operational, and the jet fuel accounts for a substantial cost in operating their business. We all know that oil prices (and therefore jet fuel prices) are in a constant state of flux and change drastically due to political, social, and economic reasons. This makes it very difficult for an airline to get a handle on forecasting future costs, which can have serious effects on the airline's financial planning. As oil prices change, the airline may end up under budget or over budget for …
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