Wednesday, September 2, 2009

The purposes of trading in financial futures(2)

Many financial analysts feel that the relationship between prices in the spot securities market and in the financial futures market is more stable and predictable than is true of prices in either market considered separately. This relatively stable relationship between spot and futures prices is what allows investors to reduce risk by hedging in financial futures.
Under a financial futures contract, the seller agrees to deliver a specific security at a specified price at a specific time in the future. Delivery under the shortest contracts is usually in 3 months from today‘s date, while a few contracts stretch out to 18 months or even two years. When the delivery date arrives, the security‘s seller can do one of three things (1) make delivery of the security if he or she holds it; (2) buy security in the spot (cash) market and deliver it as called for in the futures contract; or (3) purchase a futures contract for the same security with a delivery date exactly matching the first contract. This last option would result in a buy and sell order maturing on the same day, which "zero out" and clear the market. In reality, settlement of contracts generally occurs exclusively in the futures market through offsetting buy and sell orders rather than by using spot (cash) transactions.

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