What Are Futures In Finance And How Do They Manage Risk?

Key Takeaways

• Futures protect you from the uncertainty of price changes. Using futures, you can fix the price of an asset today and complete its transaction in the future at the same fixed price.
   
• Futures offer you various characteristics like margin requirement, standardised contract, expiry date, and many more. These characteristics help you determine how the contract functions and what kind of risks or benefits it can offer.
   
• Using futures, you can effectively manage risks and reduce losses. You can use risk management methods like hedging, diversification, matching expiry, and many more to keep risks in control. 
   

A future in finance is a legal agreement to buy or sell an asset at a fixed price on a specific future date. The price is decided today, but the actual transaction happens later.

Suppose today, Sakshi agrees to buy 1,000 shares of a company at ₹500 per share, delivery after 3 months. The total contract value is: 1,000 × ₹500 = ₹5,00,000.

If the market price at expiry is ₹540, then Srishti’s gain is ₹40 per share, which totals ₹40,000. If the price falls to ₹470, then Srishti’s loss is ₹30 per share, which totals ₹30,000. The following table highlights how the profit or loss changes with the market price at expiry:
 

From the table mentioned above, you can see that the payment at expiry remains ₹5,00,000. However, Srishti’s overall result changes based on the market price, leading to either profit or loss.

In this blog, we will learn more about futures in finance and how they manage risk.

Key Features of Futures

Before trading futures, you need to understand the elements that make these contracts unique. The following table highlights the features of futures:
 

The features mentioned in the above table ensure that futures contracts remain standardised and transparent. This makes them easier for both traders and businesses to use effectively.

Lesser-known fact: You might not know that futures were also used by the farmers in 18th century to fix crop prices in advance, and merchants ensured a steady supply to avoid seasonal price changes. 

How Do Futures Manage Risk?

Futures are not just for speculation. They are powerful tools for protecting you against price changes. If you use the right methods, then you can reduce losses and keep earnings stable. The following table highlights how futures manage risk:
 

If you combine the strategies mentioned in the table, then you can actively manage risk and keep financial surprises to a minimum.

Final Thoughts

Futures remain one of the most versatile tools in finance. This allows traders, investors, and businesses to manage price risks effectively.

They help secure prices in advance, protect against sudden market swings, and offer opportunities for profit in rising or falling markets.

You might have understood by now that they can deliver strong returns. However, they also carry significant risks if used without proper knowledge or planning.

If you understand the future's working, benefits, and challenges, then you can protect your financial interests and achieve long-term stability in uncertain markets.

FAQs

1. What is contango in futures?

Contango occurs when the futures price of a commodity is higher than its expected spot price at contract expiry.

2. Why are futures riskier than stocks?

Futures involve leverage, which can amplify both gains and losses. This makes them riskier than holding stocks directly.

3. Who creates futures contracts?

Exchanges like NSE or MCX design standard contracts so traders can buy and sell them with clear terms.

4. Is contango bullish or bearish?

Contango is usually bullish, as it shows futures priced above the spot price. This reflects expectations of rising demand or limited supply in the market.

5. Why do traders prefer futures?

Traders prefer futures for leverage, liquidity, and the ability to profit in rising or falling markets.

6. What is the best indicator to use with futures?

Many traders rely on moving averages to spot trends in futures markets.

7. Which is more profitable, futures or options?

Futures can give higher gains in strong trends. On the other hand, options might protect you better when markets move against you.

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LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?