Advantages of futures contracts

Futures contracts refer to contracts involving predicted future values of currencies, commodities, and stock market indexes. Futures contracts have several advantages which include the following:

Open the markets to investors

Futures contracts are useful for risk-tolerant investors. They are a great way to trade specific investments such as commodities, currencies, and indexes. Their standardized features and very high levels of leverage make them particularly useful for the risk-tolerant retail investor. The high leverage allows those investors to participate in markets to which they might not have had access to otherwise.

Stable margin requirements

The margin requirements for major commodity and currency futures are well-known because they have been relatively unchanged for years. Margin requirements may be temporarily raised when an asset is particularly volatile, but in most cases, they are unchanged from one year to the next. This means a trader knows in advance how much must be put up as initial margin.

Hedging risk exposure

Futures are very important vehicles for hedging or managing different kinds of risk such as foreign currency risk, interest rate risk and price fluctuation risk.

Liquidity

Most futures markets are very deep and liquid, especially in the most commonly traded commodities, currencies, and indexes. This gives rise to narrow bid-ask spreads and reassures traders that they can enter and exit positions when required or wish to.

Simple pricing

Futures pricing is quite easy to understand. It’s usually based on the cost-of-carry model, under which the futures price is determined by adding the cost of carrying to the spot price of the asset. If the spot and futures prices are out of alignment, arbitrage activity would occur and rectify the imbalance.

Efficient and fair market

It is difficult to trade on inside information in future markets as the future is unpredictable thereby affording every investor an even playing field.

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◆ Cassava, Cresta Lodge, Msasa, October 30, 2019, 1000hours