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What is a futures contract? (types, terms and method of transaction)

What is a futures contract? (types, terms and method of transaction)
  • What are the specifications of the future contract and what are its types?
  • What is the concept of financial leverage in futures transactions?
  • What commodities are traded in the futures contract?

 

What is a futures contract? Futures contract is a widely used contract in the commodity exchange that has been used since 2007. According to this contract, a certain asset is traded at a certain time and at a certain price agreed upon by the parties to the contract.

 

What are the specifications of the futures contract?

These types of contracts have a specific standard and framework, and a series of information and conditions must be defined and implemented in it, which include:

  • Item base asset type
  • Base asset size of the item
  • The price of the pledged underlying asset
  • Contract maturity time
  • Initial security deposit
  • Limit of daily price fluctuations
  • Maximum order volume
  • Fees and penalties
  • Daily settlement procedure

 

Types of futures contracts

Future contracts are divided into the following two groups:

Physical commodity futures contract

In this type of contract, only physical goods such as coins, saffron, crude oil, etc. are traded.

Stock futures contract

This type of contract is focused on stocks, types of bonds, currency, digital currency, etc.

 

Common terms in futures contracts

Some common terms in futures contracts are:

  • Basic asset

It is a financial asset or a physical commodity that is traded in the contract.

  • Contract size

It is the size or quantity of goods that are traded. This amount is specified by the stock exchange organization and traders can trade an exact multiple of this amount. For example, this amount for saffron in the commodity exchange is 10 kg.


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  • Contract maturity

Each asset has a certain maturity time and only at this time it will be possible to carry out future transactions on that asset.

  • Open accrual position

It is a situation in which contract settlement, asset delivery and physical exchange have not taken place.

  • Purchase accrual position

It is called a situation in which a person buys a futures contract and undertakes to buy the basic asset at a certain price at a certain time and based on the rules and regulations of the stock exchange. If this position is maintained until the maturity of the contract, the said property must be taken over by the buyer.

  • Sales accrual position

It is said that a person sells a future contract and undertakes to deliver the basic asset at a certain price, at a certain time and according to the rules and regulations of the stock exchange. If this position is maintained, the basic asset must be delivered by the seller to the buyer until the contract expires.

  • Close the commitment

It means adopting a new commitment position; In fact, the new commitment position is the opposite of the commitment position of the game in which the individual was placed.

  • exchange room

It is a unit that is responsible for settling and monitoring the financial performance of the parties to the contract.

 

What is the concept of initial security deposit in futures contracts?

Due to the fact that the future contracts are contractual in nature, an amount is received as a guarantee from the contract parties; In fact, this money is a guarantee that the buyer and the seller fulfill their obligations. The initial security deposit at the time of placing the order is usually equal to 10-20% of the transaction value.

Considering that the daily settlement prices and subsequently the value of transactions change daily, the required security deposit is also updated daily and the profit and loss resulting from the contract is transferred to the deposit account (an account opened for depositing the security deposit) on a daily basis. ) will be deposited.

 

Minimum security deposit and notice of security deposit increase in future contracts

The minimum guarantee amount in future contracts is usually equal to 75% of the required guarantee amount. If the amount of the guarantee amount is close to this amount, a warning under the title of guarantee amount notice is given to the person to increase his guarantee amount.

 

The concept of financial leverage in futures trading

Financial leverage is a tool used to increase the return on investment. This leverage is very useful in future transactions and with its help, a person can invest multiple times of his current assets and, as a result, earn more profit. Of course, with the use of this tool, the risk of transactions increases. The amount of this leverage depends on the two items “guarantee amount” and “transaction value”. The method of calculating financial leverage is as follows:

 

Benefits of futures contracts

 

  • Risk coverage

Traders can minimize or eliminate the risk caused by price fluctuations with the help of futures contracts. For example, a farmer who is worried about the decrease in the price of his product at the time of harvest, can insure himself against future price fluctuations with the help of a futures contract and being in a selling position. On the other hand, a buyer or a producer who is in a buying position can ensure the stability of the price of primary products for production and easily estimate the price.

  • High liquidity

Due to the fact that in future contracts there is no need for the existence of the basic goods at the time of the contract, it is possible to pre-sell the goods in this type of contracts and traders can, if they wish, prepare the desired goods and deliver them to the buyer at the time of the contract maturity; This is despite the fact that the amount of the contract has been received by the seller until the due date. This will increase liquidity in the futures markets.

  • Guarantee of transactions by the clearing house

The clearing house always monitors the financial performance of the parties in the future contracts and as a strong support, it guarantees the fulfillment of the obligations of the parties and the implementation of the rules governing the contract.

  • Identifying profits by forecasting prices

Traders can predict the price of their basic commodity with the help of data analysis and price fluctuations and take a sell or buy position according to the decrease or increase in its price in the future.

  • The possibility of using the lever tool

In futures contracts, it is possible for traders to enter into a transaction with the help of financial leverage, in the amount of several times the basic asset they have in hand, and as a result, earn more profit.

Other advantages of this type of contract include low fees, transparent prices, two-sidedness of the market, daily calculation and deposit of profit and loss, the possibility of one-day withdrawal of balance from the account, tax exemption, and the possibility of unlimited buying and selling on every trading day.

Disadvantages of futures contracts

One of the disadvantages of this market is its high risk due to the presence of financial leverage.

 

How to get the future trading code and the conditions for future trading

The steps to receive the trading code of the future contract are:

  • Visiting the agency in person and presenting identification documents
  • Opening a representative account in one of the bank branches
  • Completing transaction code request forms and introducing bank information
  • Confirming the documents provided and sending the completed forms to the commodity exchange by the brokerage
  • Issuance of the future trading code by the commodity exchange and receiving it from the broker

 

The necessary conditions to access the futures contract online trading system are:

  • Having at least 18 years of age
  • Having at least a diploma
  • Depositing the initial guarantee to the proxy account

 

What are the uses of futures contracts in the Iranian market?

Future contracts were used for the first time in the Iran Commodity Exchange since 2007. Currently, these types of contracts include agricultural products, Bahar Azadi coin, copper cathode, etc. Presenting these products in the commodity exchange under the title of future contracts will clarify the prices, regular supply, determine the real prices, etc. for the sellers and buyers of this market.

Farmers and other producers who are worried about the price reduction of products due to excess supply, with the help of these transactions, they can pre-sell their products in the commodity exchange and minimize the risk caused by market price fluctuations. On the other hand, buyers can buy the products they need at a specific price and provide themselves with the possibility of planning production. These contracts can reduce the risk of price fluctuations for domestic producers.

 

What commodities are traded in futures markets?

The goods that are currently traded in the futures markets are: All-Bahar Azadi gold coin of Imam Khomeini design (RA), premium cut string saffron (Nagin), first-class string saffron (ordinary pushal), cumin, pistachio, silver, gold box Lotus, copper cathode. By referring to the following link, you can see the contract size for each of the mentioned goods:

https://rahavard365.com/future

 

Trading symbol in futures markets

Every underlying commodity in the futures market has a specific maturity date that cannot be changed. Each of these maturities is displayed with a specific symbol on the trading board. The trading symbol in normal markets consists of the abbreviation of the product name, month and year of maturity. For example, the pistachio symbol for delivery in June 2019 represents the pistachio future contract with delivery in June 2019. You can visit the Rahvard site to see futures contract symbols.

 

How to conduct futures transactions

As mentioned, in futures trading, one can predict the price of the underlying commodity in the future with the help of data analysis and economic conditions. If there is a possibility of a price decrease in the future, he should be in a selling position to sell the product as soon as possible and avoid the loss caused by the price drop. If there is a possibility of price increase, it should be placed in a buying position in order to benefit from this price increase by purchasing the desired product in order to earn more profit.

When the expiration time of the futures contract approaches, a specific time frame for the delivery of the underlying commodity is announced to the person in the selling position. During this period, the goods must be delivered to the buyer. Usually, due to limited delivery time, futures contracts are closed before maturity. In this case, so to speak, we say that the person has entered into a reverse transaction.

 

Trading fees in stock futures

The trading fee for stock futures contracts is as described in the following table:

 

Fee description Buy sale Total
broker 0.0008 0.0008 0.0016
Exchange 0.00008 0.00008 0.00016
deposit 0.00008 0.00008 0.00016
Technology management 0.00004 0.00004 0.00008
The right to monitor 0.00008 0.00008 0.00016
total 0.00108 0.00108 0.00216

 

Note that the profit is calculated from the product of the above numbers in the transaction value.

The maximum purchase and sale fee in future contracts is 200 million Rials.

 

What is the difference between a futures contract and an option contract?

In futures contracts, the parties to the contract are required to pay the guarantee and fulfill their obligations. If any of the parties do not fulfill their obligations, they will be fined. But in option contracts, the buyer has no obligation to the other party and will only deposit an amount as prepayment of the contract. In these contracts, if the person withdraws from the transaction, this amount will be paid to the seller as damages.

In this type of contract, the seller has obligations that, if not fulfilled, he will be required to pay a fine. For this reason, at the time of signing the contract, an amount is received as a guarantee from the seller, and in case of refusal to complete the transaction, it will be paid as damages to the buyer. It should be noted that in futures trading, the loss of speculation is much higher than the possible profit. While in option transactions, despite the decrease in the price of the basic commodity, the buyer’s loss is fixed and equal to the amount he deposited as advance payment.

 

The difference between a futures contract and a futures contract

  •  The similarity between the futures contract and the futures contract is that both are agreements for the delivery of a basic commodity at a future time and at a specified price.
  • The future contract is a private agreement between the parties and is done outside the stock market, while future contracts are made in the stock market.
  • The future contract is based on the main needs of the parties and does not follow specific standards and laws. While future contracts are concluded with stock exchange standards.
  • The delivery date is specified in future contracts and is determined according to the agreement of the parties. But in future contracts, the delivery date includes a period of time.
  • In the future contract, the settlement is done at the time of delivery of the goods, but the settlement of the future contracts is on a daily basis.
  • Usually, futures contracts are closed before the due date, while most futures contracts will lead to physical delivery of goods or cash settlement.
  • In the future contract, we see transparency in the prices, while in the future contracts, this transparency does not exist due to the determination of the prices by the parties to the contract.
  • Due to the fact that the future contract is not regulated under the supervision of organizations and institutions, it has a higher credit risk than the future contract.

 

An example of a futures contract

A trader plans to enter the saffron futures contract in November with a price level of 15,000 tomans per gram. Since the size of the saffron contract is 100 grams, it can open a trading position with a value of at least 1,500,000 Tomans. The initial guarantee amount for this type of contract is equal to 10% of the value of transactions, i.e. 15,000 Tomans. The required guarantee of this contract is about 112,500 Tomans and its financial leverage is equal to 10 (the result of dividing 1500,000 by 150000). If from November to January, the price of saffron fluctuates, so that taking into account the daily profit and loss, the guarantee amount is less than the minimum amount determined, the person will receive a warning from the broker with the title of increasing the guarantee amount.

Suppose in January, the price of each gram of saffron reaches 16,000 tomans. In this case, the value of the futures contract transactions is equal to 1600,000 Tomans, and by selling this contract near the maturity time, the amount of 100,000 Tomans profit has been recognized, and the commission fee should be deducted from this amount. If the price of each gram of saffron is reduced to 14,000 Tomans, there will be a loss of about 100,000 Tomans, to which the fee should be added.

 

Conclusion

Futures contracts are a type of derivative instrument based on the sale of an underlying commodity at a certain price in the future. These contracts have a specific standard and framework and were created to reduce investment risk. The presence of financial leverage in these contracts increases the attractiveness of futures markets, but it also increases the risk of transactions; Therefore, one should enter the futures market with full knowledge of the advantages and disadvantages of these contracts and the mechanism of this instrument.

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