A futures agreement is a promise to buy or sell a specified amount of a stock, security, or commodity at a particular rate at a specified date in the future. These agreements, also known as "futures contracts," are enforceable in court. They must be satisfied either through actual delivery or financial settlement.
Definitions and Futures Examples
Futures contracts are traded on futures markets. A futures contract is an agreement between a buyer and a seller that a particular asset, such as a commodity, currency, or stock, will be bought or sold for a specific price on a particular day in the future, known as the "expiration date." Commodities frequently trade in futures. For instance, if a person purchases a July crude oil futures contract (CL), they are committing to purchasing 1,000 barrels of oil at the agreed price when the contract expires in July, regardless of the current market price. The seller is also committing to selling those 1,000 barrels of oil for the agreed-upon sum. The original seller will send the original buyer 1,000 barrels of crude oil unless both parties trade their contracts to another buyer or seller by that date. Not only are these trades applicable to commodities. Futures of company stock, foreign exchange, index funds, and other financial instruments are purchased by traders. A futures contract's requirements must be met by both the buyer and the seller at the end of the contract term, regardless of the product being traded. Contracts for future deliverySymbols and Markets for Common Futures
A futures exchange, such as the Chicago Mercantile Exchange (CME) or Intercontinental Exchange, is where futures contracts are traded (ICE). The following examples, all traded on the Chicago Mercantile Exchange (CME), are popular index futures, currency futures, and commodity-related contracts:- Futures on the E-mini S&P 500 (ES) index
- Futures for the E-mini Dow Jones Industrial Average (YM)
- Euro to dollar futures (6E)
- U.S. dollar to British pound (6B) futures
- Futures for 100 troy ounces gold (GC)
- Futures for 5,000 troy ounces silver (SI)
- Futures for 1,000 barrels of crude oil (CL)
Functioning of Futures Contracts
Futures contracts always have fluctuating prices. The smallest price shift a futures contract is permitted to make at any given time during the day is called a "tick." Each futures contract being traded has a different tick size. As an illustration, while the E-mini S&P 500 (ES) trades in $0.25 increments, crude oil (CL) trades in $0.01 increments ("tick size"). The trader holding a futures contract sees a gain or loss in value with each movement tick. The term "tick value" differs by contract and refers to how much each tick is worth. A tick of movement in the E-mini S&P 500 (ES) is worth $12.50 per contract, compared to a tick in a crude oil contract (CL), which is worth $10 per tick. Note: Read the contract specifications to learn a futures contract's tick size and value. These are made public by the exchange where the futures contract is traded.Futures Trading Day
Even though those who deal with the commodities in question trade on the futures market a lot, day traders and long-term speculators also play a significant role in this market. When trading futures contracts, day traders do not intend to actually acquire (if they are buying) or distribute (if they are selling) the underlying asset, such as oil barrels. Instead, day traders profit from price changes that arise after entering a trade through a cash settlement agreement. Instead of exchanges of goods, money is used. For instance, a day trader would profit if they purchased a natural gas futures contract (NG) at $2.065 and sold it at $2.105 later in the day.Fees and Capital Needed for Futures Day Trading
Using a broker is necessary when trading futures contracts. For the trade, the broker will charge a fee known as a "commission." Day traders in futures are not required to have $25,000 in their trading account, unlike day traders in stocks. They must only have enough day trading margin for the contract they are trading, though. (Some brokers require an account balance minimum that is higher than the necessary margin.) The amount a trader needs to have in their account in order to start trade is known as margin. By contract and broker, margins differ. Ask your broker how much money is required to open a futures account (typically $1,000 or more), and then find out what the margin requirements are for the particular futures contract you want to trade. That will show you the absolute minimum amount of capital required, but you may want to trade with more than that to account for losing trades and price swings that might happen while holding a futures position. Futures can be very risky and volatile for day trading. Consider not trading futures if you don't have enough money to lose. Always assess your risk appetite before making an investment.Options versus futures
Purchasing futures options rather than outright futures contracts are one-way traders can control risk in the futures market. These options can only be exercised if specific market conditions are met. As an illustration, a trader might purchase an option to buy crude oil stock if the price increases to $40 per share. (The "strike price" is what it is known as.) Nothing will happen if the stock stays at its current level of $38 until it reaches $40. Let's say a decrease in supply pushes crude oil up to $45. The investor could then exercise their option to buy shares for $40, sell them for $45, and profit $5 per share.Futures Options Futures Contract
Futures Contract Futures Option- Represents a commitment to buy or sell at the agreed-upon price at a future date specified.
- represents a non-binding option to buy or sell
- Up until its expiration date, a contract may be repeatedly purchased or sold.
- premium price
- Contracts are fulfilled with cash payments or actual delivery of goods after the expiration date.
- executes only in the event that the strike price is reached before the expiration date
- greater risk
- a lower risk
Main Points
Futures contracts are contracts that promise to buy or sell a commodity, stock, or other security at a particular price and on a particular date in the future. They can be purchased or sold repeatedly up until the expiration date, after which they must be fulfilled in cash or with tangible goods. Supply chain participants can insure against changes in market prices for goods using futures contracts, and both long-term investors and day traders can benefit from these fluctuations. Futures trading can generate significant profits for day traders, but there are also significant risks.