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Futures contract

A futures contract is a standardised derivative obliging the holder to buy or sell an asset on a set future date at a price fixed today. Futures trade on organised markets such as VIOP with standard sizes and expiries; the clearing house acts as counterparty to both sides and absorbs credit risk.
Contents
  1. 1.Key points
  2. 2.Formula / calculation
  3. 3.Interpretation
  4. 4.Pitfalls
  5. 5.Frequently asked questions

Key points

  • The underlying can be an index, stock, currency, gold or commodity.
  • A long position gains from rising prices, a short position from falling prices.
  • because of leverage a small price move can wipe out the margin.

Formula / calculation

Theoretical futures price = Spot × (1 + Interest − Dividend yield)^(days/365). A futures price above spot is called contango, below spot backwardation. Profit/Loss = (Closing price − Opening price) × Contract size × Number of contracts.

Interpretation

A long position gains from rising prices, a short position from falling prices. To hedge, index futures equal to the stock portfolio are sold; exporters lock in FX risk by selling currency futures.

Pitfalls

because of leverage a small price move can wipe out the margin. Positions close at expiry; holding long term requires rolling contracts, which costs money. Daily settlement requires cash flow.

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Frequently asked questions

A futures contract is a standardised derivative obliging the holder to buy or sell an asset on a set future date at a price fixed today.

Theoretical futures price = Spot × (1 + Interest − Dividend yield)^(days/365). A futures price above spot is called contango, below spot backwardation. Profit/Loss = (Closing price − Opening price) × Contract size × Number of contracts.

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