Futures contracts have their advantages and disadvantages. Easy pricing, risk hedging, and high liquidity are positive aspects of trading futures. Price fluctuations, asset price reduction when a contract approaches its expiration date, and lack of control of events are disadvantages of trading futures. When comparing futures trading to stock trading, futures trading has two distinct advantages. Day trading taxes are much more favorable on futures than on stocks and futures traders do not have to worry about being tagged as a pattern day trader.
Which Best Explains What a Futures Contract Does?
A futures contract is a financial derivative. It obliges a buyer to purchase an underlying asset such as corn, wheat, or micro e-mini futures on a specific future date at an agreed upon price. Futures contracts allow investors to speculate on price direction of a commodity or security using leverage or hedge risk of loss. Commodity producers, for example, commonly use futures contracts to lock in prices when their markets are uncertain.
Who Initiates Delivery in a Futures Contract?
Most futures and options contracts are settled for cash. However, a party that produces a commodity or holds a stock may have the option to deliver the asset in question. The individual with the short position in a futures contract is the one who initiates delivery in a futures contract. They send a “Notice of Intention to Deliver” to the exchange where the contract was traded. The exchange then uses an established procedure for picking a party with a long position who will then take delivery.
Futures Contract Mark to Market
Mark to market refers to the practice of using current market value when recording the price of a security as opposed to using the book value This practice finds its most common use in futures trading where it helps make sure that margin requirements are met. If the market value falls below the necessary level in a margin account the trader receives a margin call and needs to top off their account. The practice also is used for mutual funds.
Dividend Futures Contract
While one typically thinks of commodities like wheat, corn, and soybean or micro e-mini futures when thinking about futures trading, one can also trade futures on dividends. A dividend future is a derivative contract that lets investors speculate or hedge risk on dividend payments in the future. These futures contracts can be for one company, an equity index, or a basket of companies. These contracts settle on the amount of dividend paid by the company, index, or basket of companies during the contract term.
What Is a Reserve Future Contract?
Reserve future contracts have nothing to do with futures trading. The National Football League lets teams sign players who are not on the active roster but are players that they want to keep around just in case. These players come to training camp and are available if they are needed during the season. These contracts do not pay very much but do give a player a shot at getting on the active roster. These players do not count against the team player limit, but their pay does count in tallying up the salary cap.
Futures Contract Price Convergence
Futures contract price convergence refers to the fact that the price of a commodity and the price of the futures will be equal on the last day of the term of the contract. These prices need to converge, or the price divergence provides opportunities for arbitrage. When there is arbitrage, it does not allow for price variations within or across trading platforms.
What Is a Continuous Futures Contract?
A continuous futures contract is one with no fixed end date. Such contracts are automatically renewed and remain in effect until one party chooses to terminate it. These contracts consist or normal contracts spliced together. It can be difficult to back test such contracts and determine profitability when compared to regular futures trading with regular futures contracts.