How exactly do options and futures work
Trade futures on the stock exchange
Lana Iliev, February 5th, 2021
Find out here how futures work, to what extent they are suitable for private investors, what risks there are to be aware of and what alternatives are available.
1 | What are futures?
Futures are derivatives and can be defined as standardized futures contracts in terms of quantity, quality and delivery date. They are the oldest form of derivative financial instruments.
One of the contracting parties undertakes to ...
- ... a predefined quantity of an underlying asset,
- ... at a predetermined price and
- ... at a certain point in time
- ... in a defined quality
- ... to deliver at a specific location (short position).
The other party, on the other hand, undertakes to purchase this underlying at the negotiated conditions (long position).
Futures & Options: At first glance, futures are reminiscent of options (warrants). However, there is a future no option to exercise. There is a performance obligation on both sides. Futures are therefore classified as unconditional derivatives, while options are conditional derivatives.
2 | What types of futures are there?
There are two different types of futures. To the Financial futures (also known as financial futures contracts) include futures transactions whose underlying value is stocks, interest rates, currencies or indices. Commodity Futures on the other hand, concern futures transactions on precious metals and other raw materials as well as agricultural goods.
Relatively well-known financial futures contracts are e.g. Bund futures (on federal bonds) and DAX futures (on the German share index). The investment period is 3 to 9 months. The maturities for these standardized futures contracts are March, June, September and December. The former are interest rate futures and are not suitable for private investors, as they contain a delivery obligation for federal bonds with a nominal value of € 100,000.
DAX futures on the other hand, they are now also being acquired by private investors and are comparatively easy to understand. According to their own assessment, the investor can bet on rising or falling prices of the German share index. If he suspects an increase, he buys futures. If, on the other hand, he expects falling prices, he sells futures.
3 | How does a DAX future work? - An example
You buy a DAX future with a six-month term at a DAX level of 10,000 points. For every increase in the stock index by one index point, the seller has to pay you € 25. You will have to pay the seller € 25 for each corresponding drop. The changes in the price of the German share index during the term are decisive for the creation of profits and losses in this investment.
DAX level: 10,000 points
Contract value: 10,000 x € 25 = € 250,000
Margin: 5% of € 250,000 = € 12,500
|Scenario 1: The stock index rises||Scenario 2: The stock index falls|
|The stock index rises by 50 points to 10,050. Your margin account will be reimbursed € 1,250 (50 × 25).||The DAX fell by 100 points to 9,900 points. Your margin account will be debited with € 2,500 (100 × 25). If the amount falls below the minimum amount of the margin account, the amount (margin) will be withdrawn from your bank account in cash.|
|After six months without any further changes in the DAX price, you will make a profit of € 1,250.||If there are no further price changes in the DAX within six months, you have suffered a final loss of € 2,500.|
|Based on your capital investment (margin), this results in a profit of € 1,250 or 10%, which corresponds to 20% p.a.||In relation to the capital employed, that is 20%, i.e. you suffer a loss of 40% p.a.|
4 | Who is buying futures?
First of all are Futures on commodities especially interesting for companies. For Manufacturing company Price hedging is particularly important, e.g. for agricultural or raw materials that are exposed to strong price fluctuations. Industrial companies, e.g. in the food industry, use futures, e.g. to buy a required food raw material (e.g. nuts for the production of chocolate cream) at a fixed price in the future. This is how they protect their business from price increases.
Futures on commodities enable trading transparency and cost efficiency. In these cases, goods are actually exchanged for money. These commodity futures are too risky for private investors.
There are also funds that specialize in investing in futures. These will "Managed Futures Fund" called.
At Financial futures contracts on the other hand, the exchange takes place less often as a real exchange, but mostly in money. As a result, they are mainly used by hedge funds for hedging purposes. Also Private investors and day traders try to profit from trading futures. But caution is advised here because, like other derivatives, futures involve great risks.
5 | Where are futures traded?
Futures are on special futures exchanges, e.g. on EUREX in Frankfurt, a subsidiary of Deutsche Börse. In contrast, futures that are not traded on the stock exchange are classified as Forwards designated.
6 | What are the costs of buying a future?
When purchasing a future, the buyer must no bonus pay (option price for the option), as there is no right to choose but an obligation to purchase. However, a security deposit (or margin payment) in the form of a down payment (between 5% and 15% of the contract value) is generally required when purchasing the future. One also speaks of “acquisition on margin”.
The Security deposit is variable as it relates to the ratio of advance to contract value. If the margin falls, the broker can Margin payments or close out the position or resell the contract, which can lead to losses for the investor. If, on the other hand, the margin increases, the buyer usually receives an interest credit.
7 | What are the risks?
As is already clear in the example calculation, investing in futures also offers attractive potential returns high risk of loss beyond the existing capital (obligation to make additional contributions).
Criticism: In addition to the high risk for investors, the macroeconomic effects are also often criticized. Because speculating in futures can lead to the formation of a bubble within a commodity market. In 2008, for example, a price bubble burst on the crude oil market due to speculation in futures. It is also believed that speculation in futures is driving up food prices around the world, which makes this type of investment unethical.
Futures are leverage instruments because investors only buy them on margin and initially require little money to invest. However, there is always the risk that only a small amount of liquidity is invested, but in the event of a loss due to the additional payment obligations, more liquidity will flow out than the private investor can cope with. Before investing, you should be clear about how much money you could possibly lose and whether your financial situation allows this.
Investing in futures sets a high level Market knowledge, Risk awareness and financial reserves ahead on the investor side. Therefore, these financial instruments are not recommended for beginners. There is no way of limiting risk as with certain types of certificates with futures.
Real estate crowdinvesting is also a good way of investing with little capital. That depends on BERGFÜRST Minimum investment volume just at 10 €. You must also use the investment options provided here no obligation to make additional contributions fear and it will be a fixed rate between 5.0% and 7.0% p.a. agreed.
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