Translate This!: “I am getting into the futures market to hedge my stock.”

By: Julio Perez, Spring 2018 IAC Graduate Research Assistant

I tend to harp on how unintuitive most investment terms tend to be, but futures tell you everything you need to know about them right in the title. Futures contracts (also known as commodity futures contracts) are agreements made to buy or sell a specified quantity of a commodity at a specified price at a specified date in the future. In other words, instead of agreeing to buy five shares of fruit leather at $1.50 a share right now, you will buy said shares at said price in a week.

What’s the purpose of this delay? Well, say you agree to purchase stock in fruit leather a month from now, at the current price of $1.50. It is unlikely that same stock will be worth $1.50 in a month, so you stand to potentially make a profit if you agree to buy the stock at a certain price and the price increases by the time your contract becomes due. Inversely, you stand to make a profit if you agree to sell that same stock and there is a drastic price change in the market.

Like everything in investments, however, you stand to lose a good deal of money if you predict the price of a stock will increase and it takes a downturn instead, with speculators often losing it all due to overzealous investing.

As previously explained, said futures contracts can be used to hedge your investments, minimizing your loss if you invest in the value of stock increasing (by simply buying the stock on the market) and potentially making a capital gain should the value of the stock fall (by purchasing a futures contract foreseeing such downturn).

Unlike most other forms of securities trading, the SEC does not regulate futures trading, but rather refer complaints and legal issues regarding fraudulent futures trading to the Commodity Futures Trading Commission (CFTC). Although the SEC does not regulate the market, they do warn consumers of websites promising high yield investment opportunities in futures, options, forex(?), hedge funds, or precious metals (anyone want to buy some gold?). The CFTC itself posts fraudulent websites as alerts to potential investors. The CFTC also provides a search engine to verify the legitimacy of investment professionals or commodities, found here.

Translated:I think fruit leather stock will rise in the future, so I will promise to buy it at a lower price and make a profit.”