Who Trades Futures?
The traders who trade futures are generally classifieds into two groups. These groups are known as hedgers and speculators.
Hedgers in futures trading: The hedgers are the futures traders having a keen interest in the fundamental asset which can comprise of an intangible entity such as an index or interest rate. The aim of these traders is to hedge out the risk if there are nay prices changes.
Speculators in futures trading: The speculators are those future traders who are interested in making a profit by forecasting the market moves. They open a derivative contract related to the asset on paper, which otherwise is of no practical use for or intent to actually take or make delivery of the fundamental underlying asset. In other words, the speculators as investors are seeking exposure to the asset in a long future or the opposite effect via a short future contract.
Let us have a look at some of the examples which will give a better idea regarding who trades futures and how?
The hedgers who are trading futures are usually the owners of the asset or the producers and consumers of a particular commodity which is under the influence of certain things like rate of interest. Here is an example- The farmers in the traditional commodity markets, often sell futures contracts for the crops and livestock being produced by them in order to guarantee a certain price, making it easier for them to plan. In the same way, the producers of livestock often go for futures contracts to cover their feed costs, so that they can plan on a fixed cost for feed. In today’s financial markets, the producers of interest rate swaps use the futures contracts or equity index futures to minimize the risk on the swap.
Here is another example which in which both of the hedge and speculative techniques is having a mutual fund account, with the investment objective to track the performance of a stock index like the S&P 500 stock index. The cash inflows are managed by the portfolio manager in an easy and cost effective manner by investing in S&P 500 stock index futures. This gains the portfolio exposure to the index which is consistent with the fund or account investment objective without having to buy an appropriate proportion of each of the individual 500 stocks just yet. This way, the balanced diversifications is preserved which helps in maintaining a greater degree of the percent of assets invested in the market and helps reduce tracking error in the performance of the fund.
Thus we see that the hedgers and speculators who trade futures make the most use of futures trading in the area of the transfer of risk, and greater liquidity between the investors with different preferences regarding time and risk.