“A guy who thought Bird flu strain coming this year so he got contracts of tons of eggs. It turns out that he hit a lottery as farmers across the nation had mascaraed their chicken due to bird flu. He got in about 3750 contracts cashed out of 4400.
He apparently did not get all his contracts out and now the people contacting him saying he needs to take the physical deliveries of the eggs. Now he has to take the physical delivery of 10 contracts and each contract contains 5 metric tons of eggs.
The worst thing is that he just lives in an apartment and could not take the delivery of 50 tons of eggs coming to his doors.”
There are some comments on reddit on the delivery of 1.2 millions eggs at doors-
Let’s understand about future contract-
A futures contract is a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future. These are standardized contracts in terms of quality and quantity.
However, these contracts represent an obligation for the buyers and sellers to sell and buy the underlying asset at the end. However, the buyer and seller can end the agreement anytime before to the last date. So, we can say that these contracts give the right choice to buyer se well as seller.
There are two type of investors who use future contracts-
- Hedgers – They buys or sells the actual physical commodity.
- Speculators – They are the investors who do not intend to take delivery, but they just want to make profit.
There are some advantages and disadvantages of future contract-
Advantages-:
- Future market is more volatile as compare to the share market, So it is having more risks and provides the more profit.
- In future market an investor can make big investment with small amount of money. This is because an investor usually needs to deposit 10% to 15% of the value of the trade.
- In comparison to other investments, the trading charges are less in the futures market.
Disadvantages-:
- As it is much volatile, So the investors get the huge losses including their margin money.
- A futures market is comparatively harder to understand than the stock market.
Now let us take an Example to understand better about future contract-
Mr. Y expects the eggs prize rise before May due to bird flu. Currently, the eggs contract for May is selling for $10/dozen. Mr. Y buys one contract (1000 dozen eggs). Now if near the expiry, the eggs price rises to $15/dozen, Mr. Y make a profit of $5000 [($15 less $10)*1000]. And, if the eggs price drops to $5, Mr. Y will get loss of $5000[($10-$5)*1000].
The above example was involving a speculator. Let us consider another example but this time of hedging.
A farmer is planning to sell the 1000 dozen eggs in next months. The current eggs price is 10$/dozen and the farmer is okay to sell these eggs at this price. However, the price could change a lot in the six months. If the farmer expects the price to rise in the future, then he would not want to lock the price. But if the price drops, then he would want to lock the price by using future contract.
Now, Assume the cost of per dozen eggs become $15. By entering the contract, the farmer will have the obligation to deliver 1000 dozen at $15.
Key points to understand before getting into future contracts-
- You should know the full Market before betting on a future contract.
- It involves risks and speculators can lose even their initial margin (because futures use leverage) if the price swings the other way.
- In between buyer and seller, if one of them gets a profit then the other will have to face losses.
- In some cases, however, futures contracts will require physical delivery, So always ready for physical deliveries.
At last I would like to say that the future contract is a zero sum game. This means if one party is making million dollars then the other party losses the millions of dollar. Future contract is much volatile, So it gives chance to investor to make huge profit and as well as loss.