Forward transactions are regarded as risky. But what is really behind options and futures, and what makes it so risky?

Forward transactions are actually in agriculture. For a long time farmers try their products as early as possible to sell to dealers in order to protect their income against the risk of a price decline. The dealers can protect yourself on the other side against rising wholesale prices. In other words, they speculate on rising prices. The industrialization and the development of financial markets have increased the demand for futures contracts for commodities, currencies and equities. Whether used for hedging or for speculation, futures gained at the end of the 19th Century in importance. Today, they are indispensable in the business world.

Forwards and futures contracts are unconditional

Contracts between a farmer and a merchant were not previously standardized. The farmer sold his expected harvest at a predetermined price. The delivery period depended on the time that is left until the harvest. Such a non-standardized forward contract is called forward. With the founding of the Chicago Produce Exchange in 1874, the first futures exchange, began the standardization of contracts. Both the quantities and delivery times have been standardized. Standardised forward contracts traded on the stock market called futures. Otherwise, the character of the contract has not changed. Even with a certain amount of a futures product at a predetermined price on an agreed date will be sold. Forwards and futures contracts are so absolute, since the time of delivery will take place in each case, a commodity exchange. The only way to prevent an exchange of goods, is the exact opposite conclusion of a business.


Long and short – positions in a business appointment

For futures trading special terms have been defined. “Long” is available for purchase here and “short” for sale. The farmer in the previous example is therefore short futures, he sold his wares to the publicly-quoted futures price. The dealer goes according to Long. Who wants to liquidate a long position, so would like to avoid a delivery of goods, must be received before the due date of a short futures position by the same amount. The win-loss profile of a long futures position is comparable with the gain or loss arising from the purchase of goods. That is, who goes long futures, wins and loses from rising prices and falling prices. The win-loss profile of a short futures position is exactly reversed. Here, the extent of profit and loss is not limited.

Options give the buyer the right to choose

Option is the English word for suffrage. The buyer of an option (long option) shall be granted the franchise to buy or sell a commodity. For this right the buyer pays an option premium. The seller of an option (short option) is however, a duty to buy or sell a commodity, if the buyer claims his right to vote to complete. Futures and options, for an exchange of goods takes place only if the option buyer chooses. Whether the buyer exercises his option depends on how developed the market price of the underlying commodity. The market price of the option must match the previously agreed price, the strike price will be compared. What is the relationship market price and strike price must be depends on the type of option.

Call and put options

Options that give the buyer the right to buy a commodity is called Call option. Put options, however, grant the right to sell a commodity. Anyone who has bought a call option (long call), will buy the underlying commodity only if the strike price below the market value of the cargo is. If the strike price at maturity of the option on the market value, the buyer will void the option because he can buy the goods cheaper in the market. Conversely, a long put option is exercised only if the strike price is above the market price, because otherwise the goods are sold at a higher price in the market.

Hedging or speculating

Put options are in the nature of insurance. Anyone who has purchased shares and wants to protect itself against a possible drop in prices, buying put options. The payment of the option premium is the payment of an insurance premium equal. If the price declines in fact, the buyer may sell the put option strike price for its shares, thus avoiding a loss. The share price rises, he lets the option expire and gains on the other side of his shares. The loss is limited to the amount of the option premium. So put options to hedge, that hedge, a portfolio of shares to be used. Call options on the other hand are mainly used in speculation. Since option premiums are significantly lower than stock prices, option buyers can make profits with much lower stakes, and thus enhancing their returns. This effect is called leverage or leverage.

For private investors are only of limited contracts

Forward transactions are regarded as significantly more risky than the underlying goods-altitude, or financial transactions. This is related to different aspects of contracts. Firstly, the greater leverage to profit and loss swings. Secondly, short positions can result in losses that exceed the capital employed. This is why private investors are excluded from many transactions. For the most personal investing, the purchase of call or put options in question, there are limited in these transactions, the losses on the option premium. But these contracts are only for private investors who are able to assess the risks from the leverage of options.