A futures contract is a forward economic transaction traded in the context of an organized market. It is an agreement that binds the contracting parties to:
- Buy or sell a specific asset (underlying asset).
- On a future date (expiration date).
- At a pre-determined price (futures price).
The buyer of a futures contract takes a "long" position, committing to buy the underlying asset at the futures price on the maturity date.
The seller of a futures contract takes a "short" position, committing to sell the underlying asset at the futures price on the maturity date.
An investor can open a position by buying or selling a future, intending to hold the commitment until the contract's maturity date (when the asset must be delivered or received). However, the investor may also choose to terminate their position before the maturity date by performing an opposite transaction: selling if the position was a purchase and vice versa.
The existence of futures contracts on various underlying assets allows investors to take positions in different markets through a series of operations classified as follows:
Speculation: Based on specific expectations about the future price movement of an underlying asset, speculation involves anticipating the market by taking the corresponding position in futures:
- Bullish expectations: Buy futures.
- Bearish expectations: Sell futures.
Hedging: Hedging is a technique for reducing market risk in a particular position, meaning the potential loss caused by an unfavorable price movement of an asset.
This involves taking an opposite position in the futures market to the one held or expected in the spot market:
| Position | Risk to cover | Hedging operation |
|
Portfolio of: - Equity securities - Fixed income - Currencies | Falling prices | Sell futures on the asset to hedge against |
|
Expectations of acquiring in the short term a portfolio of: - Equity securities | Rising prices | Buy futures on the asset to hedge against |
Arbitrage: Two different financial assets that generate the same future return must always have equivalent prices. When this basic principle is not met, an arbitrage operation can be performed: the possibility of earning a risk-free profit by simultaneously conducting opposing buy and sell operations in two different markets.
The forward price formation of any asset only incorporates the net financing cost. In other words, the theoretical price of a future is the price that makes buying the asset today financially equivalent to doing so on the maturity date.
Occasionally, actual futures market prices may differ from theoretical prices. In these cases, arbitrage opportunities arise operating simultaneously in the spot and futures markets.
This type of operation not only provides profits to the arbitrageur but also corrects the imbalance, enabling an efficient price formation process between the spot and futures markets.