Using Futures Contracts to Transfer Price Risk

As businesses grow and expand, it becomes increasingly important to manage the associated risks. One of the risks that businesses face is price risk, which occurs when the price of a key input or output that a company relies on fluctuates. This can significantly impact revenues and profits, and therefore businesses need to implement strategies to manage this risk. One such strategy is using futures contracts to transfer price risk.

A futures contract is an agreement between two parties to buy or sell an asset at a predetermined price on a future date. These contracts are widely used in commodities markets such as oil, wheat, corn, and metals. However, they can also be used in other markets, such as currencies and interest rates.

How it works

In the case of price risk management, a business would typically enter into a futures contract to lock in a price for a commodity or asset that they rely on. For example, if a company uses a specific type of oil in manufacturing, they would purchase a futures contract that allows them to buy the specified quantity of oil at a predetermined price on a future date. This approach provides certainty about the cost of the input, which enables the company to plan more effectively and reduce the impact of price fluctuations.

Suppose that the market price of oil increases in the future. In that case, the company`s futures contract ensures that they can still purchase the oil at the lower predetermined price, thus avoiding the impact of the price increase on their costs. Conversely, if the market price of oil decreases in the future, the company is still obliged to purchase the oil at the predetermined higher price. However, in this case, the company may be able to take advantage of the lower market price for future purchases, making the higher contract price less impactful.

Benefits of futures contracts

Using futures contracts to manage price risk has several benefits for businesses. These include:

1. Predictability: Futures contracts provide certainty about the cost of key inputs or outputs, enabling businesses to plan effectively.

2. Risk management: By locking in a price for an asset or commodity, businesses can reduce their exposure to price fluctuations.

3. Competitive advantage: Predictable costs can provide a competitive advantage in pricing and budgeting.

4. Portfolio diversification: Futures contracts can provide a means of diversifying a company`s investment portfolio.

Challenges of futures contracts

While futures contracts are a useful tool for managing price risk, they do have some challenges. One of the primary challenges is that they are a derivative product, meaning that they derive their value from an underlying asset. Therefore, their value can fluctuate based on changes in market conditions, making them subject to market risk. Additionally, futures contracts require an upfront deposit, known as a margin, which can be a significant cost for businesses.


In summary, futures contracts are an effective tool for managing price risk in businesses. They provide certainty about the cost of key inputs or outputs and can help businesses to plan more effectively. However, they do have some challenges, such as market risk and upfront costs. Therefore, companies need to carefully consider whether futures contracts are an appropriate tool for managing their price risk.