Daily Settlement of Futures Contract Example: Understanding the Basics of Futures Trading
Futures trading is a financial product that allows traders to buy or sell a particular asset at a predetermined price and date in the future. This form of trading is highly popular as it allows traders to make profits from price fluctuations, without necessarily having to own the underlying asset. Futures trading is often used to hedge against risks or to speculate on price movements. One of the critical aspects of futures trading is daily settlement, which ensures that traders` accounts are settled at the end of each trading day, in accordance with the market prices.
What is Daily Settlement?
Daily settlement is a process that occurs at the end of each trading day, whereby profits and losses on open futures contracts are realized, and accounts are adjusted accordingly. In a futures contract, the buyer agrees to purchase and receive the underlying asset, while the seller agrees to sell and deliver the underlying asset, at a specific price and date in the future. If the current market price of the asset is higher than the futures price, the buyer can make a profit, while if the market price is lower, the seller can make a profit. Daily settlement ensures that any gains or losses on open positions are settled daily, rather than waiting for the contract`s expiration date.
Daily Settlement Example
Let`s assume that a trader buys a crude oil futures contract at $60 per barrel, with a quantity of 100 barrels, and the contract`s expiration date is in three months. If the market price of crude oil increases to $65 per barrel by the end of the first trading day, the trader will make a profit of $500 ([$65-$60] x 100). This profit will be credited to the trader`s account at the end of the day. If, on the other hand, the market price of crude oil declines to $55 per barrel, the trader will make a loss of $500 ([$60-$55] x 100), which will be debited from the trader`s account. In this way, daily settlement helps to ensure that traders` accounts are adjusted based on the daily market fluctuations.
Conclusion
Daily settlement is an essential aspect of futures trading, as it ensures that traders` accounts are adjusted daily, based on the current market prices. By understanding the basics of daily settlement, traders can make informed decisions and manage their risk effectively. As a professional, I hope this article has provided a clear explanation of daily settlement of futures contract example. If you are interested in futures trading, it is essential to conduct thorough research and seek professional advice to ensure that you make informed decisions based on your financial goals and risk appetite.