What are the benefits of forward purchases?
What are futures trading and what are the advantages and disadvantages for buyers and sellers in a context of inflation? We explain how futures market operations work, a type of trading that was already in use in Ancient Egypt.
In the financial sector, a futures transaction is nothing more than “a purchase and sale that will take place in the future, but for which we agree the price today”, as Mireia Cano, 11Onze’s head of agents, explains. Ancient civilisations such as the Egyptians and the Romans already used this type of agreement to buy raw materials or agricultural products before the harvest. Today, many types of products, from commodities to currencies, can be bought and sold on futures markets.
Futures transactions are traded in an organised and controlled market. To minimise the risk of the transaction, the two parties “provide a deposit that commits them to carry out the transaction, or to assume the penalty otherwise,” according to Cano.
In financial terms, the selling party is said to have a short position and the buying party a long position. The agreement between the two parties must specify the asset, i.e. the product or commodity being traded; the quantity of this asset; the price and the way in which the contract will be settled; the place and conditions of delivery, as well as the maturity date of the operation.
The benefits of futures trading
Obviously, the market price of the agreed product can go up or down between the moment we formalise the operation with a closed price and the maturity date. Depending on the evolution of prices, it may be the buyer or the seller who benefits financially from the transaction. “Therefore, forward purchases are a question of time and risk,” says Mireia Cano.
In any case, both parties benefit from this type of operation in the sense that they are protected against market volatility and are guaranteed a purchase or sale that is necessary for them. These certainties are especially important for individuals or companies that buy or sell a large volume of products, as prices can change a lot, especially in such an inflationary context.
Another point in favour of buyers is that the execution cost, i.e. the margin they negotiate and advance to the seller at the trading stage, is usually low and fairly standardised, except when the underlying asset is highly volatile. In addition, the futures market offers “great liquidity because, as it operates on a daily basis, there are many facilities for placing orders every day and quite quickly,” explains the 11Onze’s head of agents.
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