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Essentials of Futures PDF |
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Introduction to Futures
Futures contracts—agreements that establish a price level today for a specific quantity of items to be purchased or sold in the future—can provide opportunities for better managing risks in a diversified¹ portfolio and profiting from expected price movements in these markets.
The Seed of the Futures Markets
Before the establishment of central grain markets in the mid-nineteenth century, farmers hauled their newly harvested crops to major population centers each fall in search of buyers. The autumn surplus led farmers to slash prices and, often, to dispose of leftover goods. Springtime shortages usually followed, as did exorbitant prices. Futures markets addressed this dilemma by allowing organized, competitive bids for commodities. This continuous auction market for buyers and sellers proved beneficial to all and additional auctions developed—including those for currencies and financial futures.
The Long and Short of It
Today, individuals and businesses can buy and sell futures contracts—agreements that establish a price level today for items to be delivered in the future—in an attempt to protect against adverse price changes. The buyer of a futures contract believes that prices will appreciate and so is said to have a “long” position, whereas the seller believes that prices will decline and thus has a “short” position. Futures prices are set by factoring in historical trends to anticipate what the price will be at the end of the contract—generally several months to two years in duration.
Futures contracts are agreements—between buyers and sellers—that establish a price level today for items to be delivered in the future. A supermarket chain might buy a coffee futures contract to hedge against an increase in coffee prices.
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¹ Diversification neither assures a profit or eliminates the risk of experiencing investment losses.
This educational piece is not intended to be comprehensive. Before investing in managed futures, be sure to discuss them with your financial advisor to make sure they are appropriate for your time horizon, risk tolerance and objectives. Investors should be aware that there are risks, special costs and requirements associated with financial futures and that they may not be appropriate for all investors. When owning futures, investors should consider the impact and risk of maintaining a margin account. Margin is defined as borrowing money from a broker/dealer to purchase securities. It is sometimes called “buying on margin.” Should an adverse price movement affect your securities, a margin call will be issued, which demands additional investment to cover the loss. Failure to meet a margin call can result in losing more than your original investment. Futures should be regarded as short-term trading vehicles and should be regarded as inappropriate for anyone who is unable or unwilling on short notice to access other financial assets in order to meet margin calls on open futures positions.
The information provided here is intended to be general in nature and should not be construed as investment advice or a recommendation of any specific security or strategy.
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