Futures Contract: Meaning, Definition, Pros & Cons

Futures contracts are extensively used for trading in futures exchanges. However, every trader needs a certain degree of experience and knowledge to successfully complete future trades. They are recognised as binding contracts. They permit the owner as well as that writer to either purchase or sell a respective stock/commodity at a predetermined date and rate in the future.

Future contracts have numerous advantages and disadvantages. The most prevalent benefits include simple pricing, high liquidity, and risk hedging. The primary disadvantages are having no influence over future events, price swings, and the possibility of asset price declines as the expiration date approaches. Discover below everything you need to know about futures contracts.

What do You Mean by a Futures Contract?

Every finance market enthusiast might be familiar with the term futures contract. A Futures Contract is nothing but a legalised contract designed for two distinguishing parties looking to secure their underlying assets, such as commodities, stocks, and bonds against the volatility of the market. That being said, a futures contract is much more complex in nature.

Hedgers typically look for security against price volatility in the future. Instead of wanting to earn a profit from the respective deal, they look for securing the cost of their products. Thus, it is a given that the profit or loss that might come from the sale is majorly offset by the cost of the underlying assets in the market. 
Speculators, however, almost always trade against different trends in the market. They invest in a futures contract to make and attempt to sell it for profit in situations of price rise. Nonetheless, this trading must be done prior to the expiration date of the futures.

Futures trading by itself is a zero-sum game. It plays a quintessential role in ensuring that the prices of the products in the market aren’t impacted. Therefore, it locks the price. It offers complete security against potential price swings not may be predictable in the market.

Pros and Cons of Futures Trading

Profit and loss concerning futures trading are generally boundless. Everyday price swings make these trades rather volatile. Let’s look at some pros and cons of futures trading to learn about this better.

Pros

• One of the unbeatable benefits of futures Contracts is that investors can work with futures prices associated with the underlying asset cost in the market. 

• Traders make use of these types of contracts for hedging against potential price drops in the future market. 

• Additionally, investors can significantly Dave themselves from paying straight up through leveraging margin. 

Cons 

• While the benefits of futures contracts are plenty, they come with their own set of risks. Speculators can thus lose initial margins as well if there is an opposite swing in the price.

• Investors may tend to lose out on desirable price perks on entering a futures contract. 

• Investors can also encounter potential losses when using margin.

Bottom Line

It goes without saying that the market of commodity futures is extensively volatile. Traders can gain profits or encounter losses based on their skills and expertise. Thus, every futures trading enthusiast must have the required skills and expertise, along with the ability to take risks for encountering successful trades.