Overview
This lecture covers the fundamentals of futures contracts, their mechanisms, uses for hedging and speculation, main products in the futures market, and a famous real-world example of futures trading impacting global finance.
What Are Futures?
- Futures are standardized contracts to buy or sell an asset at a predetermined price on a specific date.
- Each contract specifies the asset, amount, price, and expiration date.
- Futures can be traded freely in the market; buyers are "long," sellers are "short."
Uses of Futures: Hedging and Speculation
- Suppliers and buyers use futures to lock in prices and hedge against price fluctuations (e.g., farmers, manufacturers).
- Speculators use futures to profit from expected price movements without holding the physical asset.
- Most futures contracts are closed before expiration, avoiding physical delivery.
Types of Futures Products
- Interest rate futures (e.g., SOFR, Eurodollar) are the most traded, used to hedge interest rate risk.
- Stock index futures track market indices (e.g., S&P 500, NASDAQ) for broad market exposure or risk hedging.
- Commodity futures include oil, gold, wheat, etc., used by producers, consumers, and speculators.
- Other futures exist for foreign exchange, volatility (VIX), weather, carbon credits, and even abstract indicators.
Key Characteristics of Futures
- High leverage allows large positions with relatively little capital.
- Easy short selling: both long and short positions are symmetrical and accessible.
- High secrecy: traders' identities are hidden; only price and volume information are public.
Real-World Example: Soros and "Black Wednesday"
- George Soros used leveraged futures to short the British pound in 1992, exploiting economic divergence between the UK and Germany.
- Large-scale futures trading pressured both futures and spot markets due to arbitrage.
- The Bank of England exhausted reserves trying to defend the pound, leading to its forced devaluation.
- Soros profited over $1 billion from this trade, showcasing the power (and risk) of futures leveraging.
Advanced and Unconventional Futures
- Perpetual futures in crypto never expire and purely track price movements.
- Futures can be designed on virtually any quantifiable indicator if enough participants are willing.
Key Terms & Definitions
- Futures Contract — Agreement to buy/sell an asset at a set price on a future date.
- Long — Position betting the price will rise; buyer in the contract.
- Short — Position betting the price will fall; seller in the contract.
- Hedging — Using futures to reduce exposure to price risk.
- Leverage — Using a small amount of capital to control a large position.
- SOFR — Secured Overnight Financing Rate, a key benchmark for US interest rate futures.
- Stock Index Futures — Futures tracking a market index rather than individual stocks.
- Arbitrage — Exploiting price differences between futures and spot markets for profit.
Action Items / Next Steps
- Review the mechanics and examples of futures trading.
- Prepare for the next lecture on advanced futures strategies and market traps.