A future buyer, also known as the long in a futures contract, is an individual or entity who enters into an agreement to purchase a specific underlying asset at a predetermined price on a future date.
Understanding the Role of a Future Buyer
When someone becomes a future buyer, they are essentially taking on a contractual obligation within the framework of a futures contract. This means:
- Obligation to Buy: The buyer of a futures contract is taking on the obligation to buy and receive the underlying asset when the futures contract expires. This is a binding commitment, unlike an option, where the holder has the right but not the obligation to buy.
- Future Delivery: The actual exchange of the asset and payment does not happen immediately. It is scheduled for a specific date in the future, known as the expiration or delivery date.
- Predetermined Price: The price at which the asset will be bought is agreed upon at the time the contract is initiated, regardless of the asset's market price at the time of expiration.
In contrast, the seller (or the short) of a futures contract is taking on the obligation to provide and deliver the underlying asset at the expiration date. Both parties are bound by the terms of the contract.
Why Do People Become Future Buyers?
Individuals and institutions enter into futures contracts as buyers for several strategic reasons:
-
Hedging
Businesses that anticipate needing to purchase a commodity or financial instrument in the future might buy futures contracts to lock in a price today. This helps them mitigate the risk of adverse price increases.
- Example 1: A large coffee roasting company might buy coffee futures to secure the price of coffee beans for upcoming months, protecting themselves from a sudden spike in bean prices.
- Example 2: An airline might buy jet fuel futures to hedge against rising fuel costs, ensuring more predictable operating expenses.
-
Speculation
Traders who believe the price of an underlying asset will increase in the future can buy futures contracts. If their prediction is correct, they can sell the contract before expiration (or take delivery and sell the asset) at a higher price, profiting from the upward price movement.
- Example 1: An investor buys crude oil futures, anticipating that geopolitical events will lead to an increase in global oil prices.
- Example 2: A currency trader buys a futures contract for a foreign currency, expecting that currency to appreciate against their domestic currency.
Key Characteristics of Futures Contracts from a Buyer's Perspective
| Feature | Description |
|---|---|
| Obligation | The buyer must fulfill the contract by either taking delivery of the underlying asset or offsetting the position before expiration. |
| Standardization | Futures contracts have standardized specifications (quantity, quality, delivery dates), promoting liquidity and ease of trading. |
| Exchange-Traded | Futures are traded on regulated exchanges (e.g., Chicago Mercantile Exchange - CME Group, Intercontinental Exchange - ICE), ensuring market integrity and reducing counterparty risk. |
| Margin Requirements | Buyers (and sellers) are required to deposit an initial margin, which is a small percentage of the contract's total value, to open and maintain their position. This acts as a performance bond. |
How a Future Buyer Manages Their Position
A future buyer typically has two primary ways to manage their contractual obligation as the expiration date approaches:
- Offsetting the Contract: The most common approach is for the buyer to sell an identical futures contract before its expiration. This effectively cancels out their initial "long" position. The difference between the initial purchase price and the subsequent selling price determines their profit or loss.
- Taking Delivery: Less common for speculative positions, but often relevant for hedgers, is to physically take delivery of the underlying asset. For commodities like grains or metals, this means the buyer receives the specified quantity and quality of the asset at the designated delivery point. For financial futures (e.g., stock index futures), delivery might involve a cash settlement rather than physical asset transfer.
Understanding the role of a future buyer is fundamental for anyone participating in derivatives markets or seeking to manage future price risks across various asset classes.
