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In our last blog, we have covered everything about buying futures. This blog is all about selling a futures contract. If you are new to the stock market then you must be wondering why most people do trading in futures? This blog has an answer to all your doubts regarding selling futures. By going through this blog you will get to know about the benefits and reasons for selling futures. So let's dive in!
What is a futures contract?
A futures contract is a legal agreement to buy or sell a particular commodity asset, or security at a pre-defined price at a specified time in the future. These are the financial contracts that urge (or bind) the parties to buy/sell an asset at a decided future date and price. The buyer and seller of the contract are deciding to pay the price today for some asset or security that is to be delivered in the future. Futures contracts are regularized for quality and quantity to smooth out trading on a futures exchange. The buyer of a futures contract is committing to buy and receive the underlying asset when the futures contract expires. The seller of the futures contract is committing to provide and deliver the underlying asset at the expiration date. The expiry date of the futures contract is nothing but the last date of the contract. “Futures contract" And "Futures" both are the same thing.
Who uses futures contracts?
Speculators may use futures contracts to bet on the future price of some asset or security.
Hedgers make use of futures contracts to lock in a price today to reduce market uncertainty between now and the time that good is to be delivered or received.
Arbitrageurs generally trade futures contracts in or across related markets, taking advantage of theoretical mis pricing that may exist temporarily.
How do futures contracts work?
The principle of the futures contract is that the buyer must purchase or the seller must sell the underlying asset at the set price, regardless of the current market price at the expiration date. Underlying assets can be physical commodities or other financial instruments. In most cases, delivery never takes place. Instead of that the buyer and the seller who act independently of each other usually liquidate their long and short positions before the contract expires.
Selling futures
The seller of the futures contract agrees to sell the underlying commodity to the buyer at expiration at the fixed sales price which was decided at the time of contract. The price of the futures contract can change and can increase or decrease than the price decided at which the trade was initiated. This makes profits or losses for the trader. In a futures contract, an investor can make a profit from either rising or falling markets. A trader can not only realize gains from buying low and selling high but also can realize gain by selling high and buying low.
Advantages of trading (Buying and Selling) in futures
Short selling is the main advantage of trading in futures. Short selling means you can sell that futures contract that you do not owe. You can short-sell without buying the stock, and you can carry forward your position. Short selling is possible because the delivery of futures contracts is at the later date.
Investors can trade futures on margin, margin allows traders paying as little as 10 percent of the value of a contract to own it and control the right to sell it until it expires
Flexibility is also a very important advantage of trading in futures which is not provided by most traditional forms of capital investment.
Many asset classes like WTI Crude oil (CL), Chicago SRW, Wheat (ZW) futures, are readily available for trade. Futures traders can gain profit from being long or short in the market.
In day trading a trader buys and sells futures contracts within the same day. A trader must have to sell these futures contracts at the end of the day otherwise their positions automatically get squared off. Duration of day trade can vary from a couple of minutes to the whole trading session.
Reasons for selling futures Contract
Following are the primary reasons for selling a futures contract. Each has a unique objective and is executed in a specific manner.
Short selling
In short-selling traders takes a bearish view of a market and act accordingly. Short selling occurs when an investor borrows a security and sells it in the open market and plans to buy it back later for less money. In short, it is selling instead of buying. In short selling, a trader borrows stock from a broker, sells it at a high price, and waits for the price drop of the same shares, as soon as shares price drop trader buys those shares and gives them back to the broker. Here trader uses the selling high-buying low strategy. But the risk is also involved here because when the shares price increases instead of dropping then the trader faces losses because he/she must have to buy shares at any price to return them to the broker.
Trade management
This includes selling a contract (or contracts) to exit an existing long position. When the price of a futures contract becomes more than the buying price then traders sell a futures contract to gain profit or if the price of futures contracts starts dropping then also traders can decide to sell the futures contract to prevent further losses.
Risk management
Hedging or limiting risk may include taking a short position concerning futures products. For producers, the asset resources involved in delivering a commodity to market can be substantial, and opening an offsetting position in a related futures contract is one way of mitigating pricing risk at delivery.
There are many reasons for selling a futures contract such as chosen market, strategy, or product. The main motive of selling futures could be managing risk to provide liquidity in exchange for a chance at the financial reward. Depending on the behavior of a specific market traders can decide to sell to get both opportunity and reassurance.
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