The Lowdown on the Concept of Advance Commitment
Advance commitment is an agreement on the future purchase or sale of a stock or asset based on agreed terms.
Life is all about commitments, and stock trading is no different. While much of stock trading performance involves the stocks and assets you buy or sell in the present, there’s also a great deal of planning and future actions involved. Advance commitment is one such future action. It is an agreement to buy or sell an asset, with terms also agreed, at some future date.
Examples of Advance Commitment
Futures contracts are the most common example of advance commitment. Here though, the contract’s buyer or seller can step back from the contract through an offsetting position. This can be done as long as the contract has not reached the expiry date. Stock short selling is also an example of advance commitment.
Parties can make a commitment in advance to buy an asset or sell it. In a futures contract this commonly happens. According to the agreement, the individual agrees to buy the asset underlying at the pre-determined price on the expiration of the contract. The seller agrees to give the buyer the underlying asset, and in return the buyer provides him with funds. The contract for exchange-traded futures can be offset before its expiry. In this situation, the buyer or seller removes any obligation they have for buying or delivering the asset underlying after having received any gain or loss.
Futures contracts are normally used by hedgers and speculators. Purchasers or producers of an underlying asset hedge the selling or purchasing price of the commodity. Traders and portfolio managers also bet on the movements in price of an underlying asset with the help of futures.
Investopedia quotes an example. If an oil producer wants to sell their oil, they could use futures contracts. That helps them to zero in on a price at which they will sell. They can then deliver the buyer the oil on the expiry of the futures contract. A company requiring oil for its factory would plan significantly ahead to ensure oil keeps coming every month. They could use futures contracts. That would help them know the price they would pay for the oil in advance. They also know they would take delivery of the oil after the expiry of the contract.
You have futures available on various kinds of assets including currencies, commodities and stock exchange indexes.
Another example of advance commitment is short selling. Here, the trader sells a stock that he does not own yet, with the agreement to buy those shares back at a date in the future. The trader hopesthat by that date the stock would go down further. At the time of the short sale, though, the trader doesn’t know what the price will get to when he has to buy the stock.
A greater understanding of these contracts only comes with experience and a greater exposure to investment and the stock market.
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