Future Contract Settlements

Thanks guys for your support messages.

Getting back to the point... let us continue our discussion. In the last post, we discussed Hedgers and Speculators and how they help in Price Discovery and Stability of business environment. Now as promised, let us see how Future Contracts are settled.

Future Contracts these days do not see meeting between two people and a paper contract now. These contracts are highly standardized today and are traded on exchanges around the world with buyers and sellers from across the world participating. Not just because geographical diversity of market players but also because various types of players and many other complications, contracts are not settled through physical delivery anymore (at least not on most exchanges and for most underlying).

Just like option contracts, Futures Contracts are also cash settled. So at the end of the two months (or duration of contract) if the sugar cane price is in your favor, you will get the money from the exchange. Or in case unfavorable price, farmer will get the difference from exchange. Keep in mind that exchange is not playing Santa Claus here and it recovers (actually it keeps it in advance from both you as well as the farmer) this payout from the loosing party. The amount which exchanges takes from you as a deposit is known as margin and there is a tremendous mechanism behind calculation of this and believe me most people who lose money in Futures... loose it because they do not understand this mechanism.

It is almost criminal not to understand margin calculation before even thinking of Futures trading. And as you all are good friends of mine, I will definitely not want any of you serving sentences for this... so hold on, next post on Margins.