Futures, forwards and options are used for risk reduction, speculation Essay

Futures, forwards and options are used for risk reduction, speculation and arbitrage purposes - Essay Example will, however focus on three derivatives only; futures, forwards, and options contracts and evaluate their roles in risk reduction, arbitrage purposes, and speculation. Futures are also known as futures contracts in finance. By definition, a futures contract is one that is standardized and features two different parties who agree to buy and/or sell a specific asset with a standard quality and quantity for a price that is agreed on before the actual delivery and payment occurs. However, the delivery and payment day, which occurs on a future date is specified and fixed, and is referred to as the â€Å"delivery date† (Suitcliffe 2006, p. 19). For instance, one may need to buy a specific make of an asset, such as a Smartphone that happens to be out of stock at a certain shop. Owing to the fact that he needs that one make of the phone, they can come to terms with the proprietor that he imports the phone from elsewhere, then sells it to the buyer later for a price that they agree on at that current time. This contract’s negotiation takes place at a futures exchange. A futures exchange or market is itself a neutral financial exchange in whic h trades of standardized futures occur. In short, a futures market acts as an intermediary between the buyer and seller and sees to it that they come to an agreement regarding the exchange of commodities or financial instruments at a certain time with a specific future delivery time (The Telegraph 2014). The party willing to acquire an underlying asset in a later time (future) is called the buyer of the futures contract, whereas the party willing to sell the same is called the seller of the contract. Since the buyer of the contract has the permission to make a deal and await delivery without any variations to the price, he is referred to as â€Å"long†. The seller on his part who has the mandate to deliver the asset on the specified date without altering the price to the buyer is referred to as â€Å"short†. A futures contract, with