Investing in futures can be a profitable venture, but understanding the mechanics can be confusing, particularly when it comes to the concept of discounting. Discounted futures, in particular, can be a challenging aspect of trading for investors. These futures allow traders to purchase an asset at a discounted price, with the assumption that the asset will increase in value over time. In this comprehensive guide, we will provide you with the information you need to know about futures trading discount and how to make the most of them.
What are discounted futures?
Discounted futures are futures contracts traded in a futures market wherein the futures price is lower than the expected spot price of the underlying asset at the delivery date. In other words, buying a discounted futures contract lets you buy the underlying asset at a lower price than its expected market value on the delivery date.
How to calculate a discount rate?
The discount rate is the rate used to calculate the present value of the expected future cash flows. When you buy a discounted future, you’re effectively buying an asset in the future but at today’s discounted price. When calculating the discount rate, you will need to take into account the risk-free interest rate and the risk premium associated with the underlying asset. In general, the higher the risk, the higher the discount rate.
The advantages of discounted futures trading
One of the significant advantages of trading discounted futures is that it allows investors to profit from an expected future price increase. That is to say, buying a discounted futures contract locks in a lower price than investors would pay if they bought the underlying asset immediately.
Moreover, discounted futures provide investors with the flexibility to buy an asset at a later date and lock in a particular price. Additionally, they allow for hedging strategies, which is a technique used by investors to offset risks and mitigate potential losses.
Risks of discounted futures trading
While discounted futures provide traders and investors with an opportunity to make money, it is essential to also understand the potential risks associated with trading in this way. One of the significant risks of discounted futures is that the underlying asset may not increase in value as expected, leaving the investor with a loss.
Additionally, since futures trading involves a high degree of leverage, losses can add up quickly, and traders may be required to deposit additional capital to cover losses. Investors should also be aware that futures trading is highly volatile, and as such, they should be prepared to monitor their investments regularly to avoid losses.
Strategies for trading discounted futures
There are different strategies that traders use to profit from discounted futures trading. One of the most common strategies is to buy a discounted future contract for an underlying asset they anticipate will increase in value. Another strategy is to use a discounted futures contract as a hedging instrument to mitigate potential losses. A trader may hold a discounted futures contract and the underlying asset simultaneously to offset risk.
Discounted futures trading is a great way to invest in the future value of an asset while locking in a lower price today. Although discounted futures come with inherent risks, they also allow traders to profit from expected price increases and to hedge against potential losses. Before investing in discounted futures, it’s important to understand the mechanics involved, calculate the discount rate, and carefully consider the potential risks. By learning about discounted futures and applying the appropriate strategies, investors can take advantage of this in-demand investment choice.