What are futures contracts? A forward contract is often chosen as protection against a possible adverse price development of raw materials, usually a price increase. An increase in the price of kerosene or crude oil will often be at the expense of profits, but with the protection of a futures contract, significant additional profits can be made or losses can be reduced. But there are also futures contracts for Bitcoins that allow you to speculate on a price increase. You can also choose another investment product, such as an ING sprinter, speeder or a turbo from Binck, for example.
Choose a forward contract
- Which raw materials to invest in?
- Prices can be very volatile
- What is a forward contract?
- What does a forward contract oblige you to do?
- Alternatives: invest in an option or turbo
- Which underlying asset for a futures contract?
- Forwards contracts
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Which raw materials to invest in?
We mainly see forward contracts in commodity trading. Many raw materials’ prices go through the roof and then drop dramatically. This volatility is often not useful for a company, especially if there are long-term agreements. When we talk about raw materials, we usually mean:
Prices can be very volatile
Prices are rising not only due to speculation, but also due to unrest, crop failures and the ever-increasing demand for raw materials from emerging countries such as China and Brazil. A company that is highly dependent on its raw materials will want to limit the risks. This can be done by concluding futures contracts. Investors can benefit from the raw materials by:
- Buying turbos.
- Investing in companies that can easily pass on the higher costs.
- Investing in gold mines and silver mines.
- Investing in emerging countries such as China.
What is a forward contract?
A forward contract is an agreement between two parties where:
- The buyer undertakes to deliver the underlying asset at the end of the term of the contract.
- The seller undertakes to make the corresponding delivery of the underlying asset.
The buyer of a futures contract assumes the obligation to receive and pay for the agreed quantity. The seller has a delivery obligation that he must fulfill.
What does a forward contract oblige you to do?
Very characteristic of term contracts is the duty and obligation on both sides, buyer and seller. Without further measures, the losses and profits from forward contracts can be unlimited. Sometimes the turbulence is so great that even a stop-loss limit does not sufficiently protect you if you are not on the right side of the market. It must be possible to act. A sudden and terrible earthquake near oil fields or a sudden drought can wreak havoc on your financial position. And unfortunately, these are situations that can actually occur.
Alternatives: invest in an option or turbo
The obligation to purchase the underlying asset does not exist with some alternative instruments, such as an option, a turbo or sprinter:
- The buyer of an option has a right to purchase or sell the underlying asset.
- The seller or the writer of an option does have his obligations if he is asked to purchase or deliver.
- With the turbos or sprinters there is no obligation to buy or sell, but payment is made automatically as soon as the stop loss value is hit.
Furthermore, either an option or a turbo can expire worthless. Even though that chance is somewhat smaller with a turbo due to the built-in residual value. The losses and profits with forward contracts, on the other hand, can be enormous.
Which underlying asset for a futures contract?
What do we conclude the contracts on? It is almost better to answer the question why we do not enter into term contracts. The origins clearly lie in the agricultural world, potatoes, coffee, pigs, cocoa, you name it. Nowadays you will see contracts related to almost all major commodities and financial parameters such as all kinds of currencies. Nowadays you can also find this extensive scope with the turbo. A new turbo or sprinter is regularly created with which you can invest.
For financial term contracts, the futures, you can visit the Euronext options exchange. For the raw materials on Euronext.liffe and for the turbos on the regular Euronext stock exchange. But finally, there are also so-called forward term contracts, the forwards. These are mutual agreements about a future purchase/sale between two parties, such as a bank or a company. This involves very large amounts, tailor-made for both parties that do not take place via the stock exchange. That is why they are ‘over the counter’ transactions that are difficult to trade and over which private individuals have no insight.
For example, if a company like KLM Air France says it has made significant profits from oil price increases, or if Aegon says it has properly covered its dollar risks, it is not immediately clear how they arranged it. It is likely that concluding good forward contracts played an important role in this.
- Gold and the gold price 2020 and 2021