deal may be acting on the premise that the price of the underlying asset will fall. If he reads the market correctly he can acquire the asset at the terminal spot price, which, by assumption, is lower, and deliver at the initial contract price. However, he, too, may misread the market and have to face a situation where the spot price increases. If so, he will have to face the spectre of a substantial loss. Quite obviously, both parties cannot read the market movement correctly. Thus, either the long or the short is condemned to accept a loss in the case of speculation using futures and forward contracts.
Such contracts may be used as risk mitigation tools as well. The long may be a party who has a short spot position in the underlying asset, that is, he is under a prior obligation to acquire the underlying asset at a future date. His worry would obviously be that the spot price of the asset will increase and he can lock in a purchase price by going long in a forward or a futures contract.
On the other hand, the short may take the derivatives position because he has a prior long position in the underlying asset. That is, he owns the asset and is concerned about a perceived price decline. Such a party can lock in a sale price by going short in such contracts. By the time contract expiration approaches, the price of the underlying asset would have either increased or decreased. If it were to have increased, the party that has gone long would be perceived as wise and sound.
On the contrary, if the underlying asset were to have declined in value, the party with a short futures position would have credit bestowed on him for his ability to read the market accurately. In practice, only one of them will be right ex-post and, thus, while one will be complimented for his foresight, the other will be castigated for his foolishness. Such criticism is, however, unfair. For, hedgers use such contracts to mitigate their exposure to price uncertainty