Investing Basics: Futures | Summary and Q&A

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December 21, 2023
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Charles Schwab
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Investing Basics: Futures

TL;DR

Futures contracts allow businesses and individuals to navigate risk and uncertainty by locking in prices for commodities or financial instruments in the future.

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Questions & Answers

Q: How do futures contracts help businesses and individuals navigate risk?

Futures contracts allow businesses and individuals to lock in prices for commodities or financial instruments, reducing the impact of price changes in the future. For example, coffee farmers can secure prices for their beans, and homebuyers can hedge against rising interest rates.

Q: What are the key components of a futures contract?

The key components include trading hours, tick size (minimum price fluctuation), contract size (standardized quantity), contract value (notional value), and delivery method (physically or financially settled).

Q: How much does it cost to trade a futures contract?

To enter into a futures contract, traders need to meet the initial margin requirement, which is a deposit set by the exchange. This allows traders to control a larger underlying asset with a relatively small capital amount. However, leverage can lead to significant gains or losses.

Q: What is the difference between financially settled and physically settled futures contracts?

Financially settled futures contracts expire into cash at expiration, while physically settled contracts result in the physical delivery of the commodity. However, most futures traders do not take physical delivery and close their positions before expiration.

Summary & Key Takeaways

  • Futures contracts provide a way for businesses and individuals to mitigate risk and uncertainty by fixing prices for future transactions.

  • They can be used to hedge against adverse price movements, such as coffee farmers locking in prices for coffee beans or homebuyers offsetting potential interest rate increases.

  • Futures contracts also allow traders to speculate on price movements, potentially leading to profits or losses.

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