Commodity futures contracts: frequently asked questions

What is a futures contract, why does it exist, and how does it work?

QuestionAnswer
What is a futures contract?Futures contracts are standardized, legally binding financial agreements to buy or sell a specific underlying asset at a predetermined price at a future date. They are traded on futures exchanges for hedging, speculation, and risk management.
How do futures markets work?Futures markets facilitate trading futures contracts, where participants can buy or sell contracts on various assets like commodities. These markets provide a platform for price discovery, risk management, and market speculation.
What is the different between physical delivery and cash settlement in futures contracts?Physical delivery involves the actual transfer of the underlying asset at contract expiration, while cash settlement settles contract obligations through cash payments based on price differentials. The choice between the two depends on contract specifications and market preferences.
Who are the key participants in futures markets?Participants include commodity hedgers (producers, consumers), speculators, market makers, arbitrageurs, institutional investors, and retail traders. Each group plays a distinct role in market liquidity, risk management, and price discovery.
How much capital is needed to trade a futures contract?Exchanges require traders to maintain a margin, a performance bond covering potential losses. When entering a contract, the initial margin is deposited, while the maintenance margin ensures positions remain open. Margin requirements vary based on asset volatility and exchange rules.
What factors influence the pricing of futures contracts?Futures prices are determined by supply and demand dynamics, spot prices, time value, cost of carry, market sentiment, and external factors like economic indicators and geopolitical events. Arbitrage opportunities and speculator activity can also impact prices.
How are futures trades executed?Trades can be executed through open outcry (electronic trading or shouting and hand signaling) on exchange floors or privately negotiated (block trades) of the public venue. Both methods involve price negotiation and trade execution based on market conditions and liquidity.
What role do regulations play in futures markets?Regulations oversee market integrity, investor protection, fair trading practices, and operational standards in futures markets. Regulatory bodies like the CFTC in the U.S. and FCA in the U.K. enforce rules, conduct surveillance, and ensure compliance to maintain market transparency and stability.
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