What are futures and why are they bad for investing?

2024 Author: Malcolm Clapton | [email protected]. Last modified: 2023-12-17 03:44

This is a complex financial instrument that is not suitable for beginners.

What are futures

Futures is a deferred purchase and sale agreement. It indicates the price and the day on which the contract will be executed. And when that date comes, the buyer is obliged to purchase the goods at the agreed price. The seller, accordingly, must return this product.

Imagine that someone is going to emigrate in six months. Our hero does not want to leave the sale of property at the last moment, so he finds an apartment buyer right now. However, he plans to live in it before leaving. The parties conclude a futures agreement, according to which the future emigrant in six months undertakes to sell housing for 1.5 million rubles.

Will it be profitable in the end? Depends on the value of the property in six months. If it rises, the buyer wins, if it goes down, the seller.

On the exchange, contracts are concluded for the purchase of basic (stocks, bonds), as well as commodity (oil, gold, grain) exchange assets. And then there are futures, for example, on a currency index or an interest rate. It would seem, how can you buy a bet? Indeed, not everything is so simple.

There are two types of futures:

1. Delivery - when the buyer must purchase the goods on the specified date. The apartment example illustrates this.
2. Settlement - when no one sells anything. The participants in the transaction simply pay the difference in the value of the asset, depending on how its price has changed. This alignment is more typical for the exchange.

Almost all futures contracts on the exchange are settlement, not deliverable. That is, the seller, while executing the contract, will not be lucky with the barrels of oil to the buyer. The concepts of "seller" and "buyer" are generally conditional here. It's just a bet, and asset prices are the basis.

Diana Alekseeva Doctor of Law, Professor, Head of the Department of International and Public Law of the Financial University

With indices, things are the same. Nobody sells them. It's just that the parties make a conditional bet on how this or that indicator will change. And the one who wins gets the money.

How futures are traded

Let's say trader A thinks that oil will rise in price soon, so he is going to “buy” it using futures. And trader B is convinced of the opposite: oil will soon fall in price. Therefore, he is ready to conclude now a futures contract at the current oil price.

At the same time, no one sells fuel to anyone. Moreover, the seller has no oil.

A and B enter into an agreement, according to which the first one "buys" from the second one 100 barrels of oil in a week for $ 5,000 - that is, at the current price of $ 50 per barrel. On the trading accounts of both players, the exchange blocks a certain amount of money as collateral.

Usually this is 5-15% of the contract amount, although it all depends on the volatility of the asset price. This is necessary for both players to eventually fulfill the contract. The amount of the collateral is then returned to the accounts.

Diana Alekseeva

A week later, oil costs $ 55 a barrel. And the “seller” loses the amount that he would not have counted if he sold real fuel - $ 500. This amount from his account goes to the account of buyer A.

This does not mean that you can buy futures and calmly wait until the contract expires to calculate everything.

Clearing, that is, settlements, is carried out daily. Depending on the change in the value of the asset, money from the account of one player will be transferred to the account of another. For example, if the next day after the conclusion of the contract, oil prices fell by 1%, then $ 50 from account A is transferred to account B.

It is worth remembering that a futures position can be closed at any time before the date of execution - by selling a previously purchased futures or redeeming a sold one.

Igor Kuchma is a financial analyst at TradingView, Inc.

Why buy futures on an asset, if you can buy the asset itself

A logical question: if success or failure depends on how the price of the underlying asset has changed, then why can't you buy it right away? Dean of the Faculty of Economics and Business of the Financial University Ekaterina Bezsmertnaya explains with an example.

Suppose today on the stock exchange a share of company X is sold at a price of 100 rubles. You are sure that it will rise in price. The forecast comes true, the share costs 105 rubles, your profit is 5 rubles.

However, it was possible to take a risk and buy a futures, which also costs 100 rubles. But we already know that 5-15% of the value of the underlying asset is enough to buy a futures. Let's say in our case it is 10%, that is, 10 rubles. Therefore, for 100 rubles, you can buy ten futures instead of one share. And if at the time of the expiration of the contract the price of the share is 105 rubles, then the buyer will receive 50 rubles from the transaction.

What's the catch? The fact that we often make mistakes in forecasts. And the losses associated with futures are as great as the potential gains.

Ekaterina Bezsmertnaya

Let's say securities fell by 7 rubles. If we bought a share and it fell in value, we can simply keep it further. Perhaps, after some time, it will rise in price. And losses from futures are inevitable, since the term of the transaction is fixed. And they will amount to 70 rubles.

According to Bezsmertnaya, this is a primitive example. In practice, the parties to a futures contract need to be on the lookout at all times. The buyer or seller must be prepared for the fact that for every unfavorable price change at the end of the trading day, a loss is generated on his account equal to the price change multiplied by the number of contracts bought or sold.

If successful, you can earn a lot on futures. But you can easily lose even more.

Why do we need futures if the risk is so great

Futures trading is a purely speculative process. It is much closer to the lottery than to investing. The change in the price of an asset can be assumed based on objective indicators. But the will of chance is of great importance here.

This is an option for making money for traders - people who are actively involved in trading on the exchange. They make frequent short-term trades and try to make money on it. For them, futures have advantages:

• The entry threshold is lower - as already mentioned, 5–15% of the asset value is enough to guarantee the transaction. The share must be bought at full price.
• There is no additional cost to store assets. Futures are just agreements, they don't need to be saved.
• Deals are processed quickly, so the results of investments are visible pretty soon.
• Brokerage fees are lower.

Also, by selling futures, you can hedge a portfolio of securities, that is, protect against shocks in the market. For example, an investor has shares of company X, which are now worth 100 rubles. He hopes that they will rise in value, but he is not sure about this. Therefore, it sells futures contracts for them. As a result, if stocks go up, he will make money on them. If they fall in price, then futures will bring income.

Why you probably shouldn't mess with futures

If you are an active trader and spend a lot of time on the exchange, you already know everything about futures and see the risks of such transactions. For those who are just starting to invest or choose a passive investment strategy with a minimum of body movements, this is not suitable. And that's why.

• Futures are not investments at all, although they can bring income. This is a short term bet for quick profits. Someone also makes money on sports betting, but we do not call it investments.
• When buying futures, in most cases, you do not get the underlying asset. A pending share purchase contract will not make you the owner of the share. You will not be able to sell a security when it rises in price. Don't get dividends. You will not be able to claim part of the company's assets if it is liquidated.
• You can buy underlying assets and forget about them for a while. You buy a bond, periodically receive a coupon yield on it, and then the face value. You do not need to actively participate in the process. Futures require constant attention.
• To win in such risky ventures as buying and selling futures, you need to be well-versed in the exchange, understand which asset is worth how much and what dynamics it shows. An ordinary investor is hardly able to predict the changes in the value of various assets as accurately as possible.