Different types of companies may enter into futures contracts for different purposes. The most common reason is to hedge against a certain type of risk. Companies may also trade futures for speculative purposes.
Hedging
Companies may use futures contracts to hedge their exposure to certain types of risk. For example, an oil production company may use futures to manage risk associated with fluctuations in the price of crude oil.
For example, assume an oil company enters into a contract to deliver 5,000 barrels of oil in six months. The company has exposure to the price of oil going down during that six-month period. To offset the risk, the oil company may hedge by selling five contracts of oil in the month it is to be delivered. Each oil contract is 1,000 barrels. The company may offset all or only a portion of its risk. The futures contracts allow the company to manage their risk and have more predictable revenue.
Companies that do business internationally may use currency futures to offset their risk in the fluctuations of currencies. If a company is paid in a different currency than that of the country where it is headquartered, the company has a substantial risk in the fluctuations of the value of the twocurrencies. The company can lock in its exchange rate using currency futures.
Speculation
Other companies, such as hedge funds, may use futures contracts for speculation. Speculation attempts to profit from movements in the prices of futures contracts. The significant leverage offered by futures contracts are attractive to many seeking to speculate.
