10.6.4 Futures Strategies For Investors

Futures are inherently simpler than options. With options, there are four basic positions: long a call, short a call, long a put, or short a put. Futures contracts, on the other hand, have only two basic positions: long and short. Options also have strike prices, offering almost infinite strategies through the combination of different strike prices and expiration dates, along with positions in the underlying asset. The range of strategies with futures is limited by their simpler structure, involving only two basic positions per expiration date.

Buying Futures

Investors buy futures to either profit from an anticipated price increase or to secure a purchase price for a future date. The former is a speculative strategy, while the latter is focused on risk management.

Buying Futures to Speculate

Buying a futures contract to benefit from rising prices is speculative. Here, the investor usually has no intent to purchase the underlying asset but hopes to sell the contract at a higher price. The outcome depends mainly on the price movement of the underlying asset in the cash market. If the spot price rises, the futures price also increases, and vice versa.

Risks and Rewards:

• Potential Profit: Price of the underlying asset rises, leading to an increased futures contract price.
• Potential Loss: Price of the underlying asset falls, resulting in a lower futures contract price.

Buying Futures to Manage Risks

Purchasing a futures contract to lock in a price is a risk management strategy. The investor commits to buying the underlying asset at the predefined contract price upon expiration, insulating against future price fluctuations in the spot market.

Risk Management Benefits:

• Price Certainty: Secures purchase price, mitigating risk of wild price swings.

Selling Futures

Investors sell futures either to capitalize on a predicted price decline or to assure a sale price on a future date. Similar to buying, these strategies can be speculative or risk management-oriented.

Selling Futures to Speculate

Selling futures to profit from a price drop is speculative. Here, the investor intends to repurchase the contract at a lower price rather than disposing of the actual underlying asset. This strategy’s success hinges notably on the underlying asset’s spot price in the cash market.

Risks and Rewards:

• Potential Profit: The underlying asset’s price declines, leading to a decreased futures contract price.
• Potential Loss: The underlying asset’s price increases, resulting in a higher futures contract price.

Selling Futures to Manage Risks

In this risk management approach, the investor sells a futures contract to secure a selling price for the underlying asset on a future date. At expiration, the asset is sold at the contract price, indifferent to any price variations in the spot market.

Risk Management Benefits:

• Price Certainty: Locks in a selling price, shielding from unfavorable price shifts.

Key Takeaways

• Futures offer simplified strategic options: buying (long) or selling (short).
• Speculative Strategies can profit from price changes without taking delivery or selling the underlying asset.
• Risk Management Strategies ensure a fixed buying or selling price, mitigating exposure to price fluctuations.
• Understanding both risks and potential rewards is crucial for informed futures investment strategies.

Frequently Asked Questions (FAQs)

What differentiates futures from options?

Futures involve only two basic positions (long and short), whereas options include positions like calls and puts with varying strike prices, offering more complex strategies.

Can I use futures for both speculation and risk management?

Yes, futures can serve both purposes: speculating on price movements for profit or managing price risks to stabilize financial outcomes.

What risks should I be aware of when trading futures?

The main risks include price volatility in the spot market, potential losses from adverse price movements, and liquidity risks associated with contract positions.

Glossary

• Long: Buying a futures contract with the expectation that the underlying asset’s price will rise.
• Short: Selling a futures contract anticipating a drop in the underlying asset’s price.
• Spot Market: Market for the immediate delivery of an asset.
• Risk Management: Strategies implemented to minimize potential losses due to market uncertainties.
• Speculation: Trading with the aim of profiting from market price movements.

    sequenceDiagram
	    Investor->>Asset: Specifies Forecast
	    note right of Investor: Speculate or Manage Risk
	    loop Speculate
	        Asset->>Futures Contract: Sell at a higher price
	        Futures Contract->>Investor: Potential profit/loss
	    end
	    loop Manage Risk
	        Asset->>Investor: Secure purchase/sell price
	        Futures Contract->>Asset: Guarantees stability
	    end

• Investor Actions:
  • Specifies Forecast: The investor begins by making a forecast about the asset’s future price, determining whether they aim to speculate or manage risk.
• Speculative Strategy:
  • Investor’s Goal: To make a profit based on price movements.
  • Asset to Futures Contract: The asset is sold through a futures contract at a higher price.
  • Futures Contract to Investor: This transaction might result in potential profit or loss based on the asset’s price movements.
• Risk Management Strategy:
  • Investor’s Goal: To manage and secure future prices to avoid uncertainty.
  • Asset to Investor: The asset provides a secure purchase/sell price ensuring stability.
  • Futures Contract to Asset: The futures contract guarantees that the agreed-upon price is stable, thus mitigating risk.

This enhanced guide breaks down futures strategies for investors, presenting clearer insights, structure, and supporting visuals. It provides a holistic understanding and strategic advice, preparing you thoroughly for related sections within the Canadian Securities Course certification exam.