The daily fluctuations of the market determine the profit and loss in the futures contract. To illustrate how futures contracts work, suppose that, in February, a wheat producer wants to lock in the selling price (short position) for the next crop season, and a bread maker wants to lock in the buying price (long position). quantity of bread and profit potential. These two parties may enter into a futures contract to deliver 6,000 tons of whole grain bread to the manufacturer (long position) in July at the price $6 million. By entering into a future contract, each party secures a price that they agree to pay and receive in July.
Scenario 1: The price decreases
We assume that one two days later contract is entered into, the price of corn decreases to $5 per bushel. A grain producer who has a short position has earned $1 per bushel as the selling price has decreased by $1 and will sell lower. The bread maker, who has a long position, lost $1 a share to pay the purchase price agreed to pay the remaining market price in the futures contract ($6). wheat ($5).
If the price decreases, the wheat worker’s account is credited with $6,000 (6,000 bushels x $1 per bushel) and the bread maker’s account is credited with $6,000 (6,000 bushels x $1 per bushel).
Scenario 2: The price increases
Suppose that one day after the two parties entered into the contract, the price of corn increases to $7 a bushel. A grain producer who has a short position lost $1 per bushel as the selling price increased by $1 and is bound to sell higher. The bread maker, who has a long position, earned $1 a share to pay the purchase price he agreed to pay in the future entry ($6), rather than paying the remaining market price in the future. wheat ($7).
If the price decreases, the wheat producer’s account is credited with $6,000 (6,000 bushels x $1 per bushel), and the bread maker’s account is credited with $6,000 (6,000 bushels x $1 bushel).
According to market fluctuations, the policies are adjusted accordingly. Unlike stock markets where gains or losses for price changes are not realized until investors sell their stock or cover short positions, futures contracts are settled daily, which means the profit or loss after each trading session is credited or debited to the owner’s account. every day
Daily settlement can be done either by physical delivery or by cash.
In the example, if a physical delivery is made, a certain quantity of the underlying product (6,000 bushels) will be delivered by producer to exchange and through exchange to bread maker. Physical delivery is common with goods and obligations, but in practice, rarely occurs. Futures contracts are closed before maturity, either by covering the contract and covering the short position at the previous time, or by selling the contract and covering the position at the previous position.
A cash settlement is, in fact, a cash settlement in the price settlement that occurs for underlying assets that cannot be physically delivered as an index. Because of the daily settlement, many transactions in futures markets are settled in cash and physical trades in the cash market. The prices in the spot (cash) and futures markets move parallel to each other and as the delivery time approaches the futures prices converge with the purchase price. Therefore, if both parties decide to close the settlement, the contract will be terminated.
