These traders include producers, consumers, or investors with exposure to the underlying asset who employ futures contracts to lock in prices, effectively insuring against price volatility. Futures trading allows investors to lock in prices for commodities, currencies, and financial instruments months or even years in advance, providing a critical tool for managing price risk and speculation. The goal is to prevent losses from potentially unfavorable price changes rather than to speculate. Suppose a mutual fund manager oversees a portfolio valued at $100 million that tracks the S&P 500.
At the same time, an oil company is trying to lock in a price for its oil in case prices fall. These transactions take place on a regulated exchange, ensuring standardized terms and avoiding the need for the parties to know each other directly. A futures contract allows its parties to buy or sell a specific underlying asset at a set future date. The underlying asset can be a commodity, a security, or some other financial instrument.
- Other benefits include exposure to actual prices, tax benefits, and lower transaction costs.
- Moreover, a trader can opt to use spread trading between two correlated markets, as different needs tend to move in the same direction.
- Joey Shadeck is the Content Strategist and Research Analyst for StockBrokers.com.
- The trading provider or broker would loan the rest to complete the total contract value.
Treasury futures allow investors to speculate on or hedge against changes in interest rates, which affect the value of Treasury securities. For example, T-note futures are widely used to hedge against fluctuations in 10-year Treasury note yields, which are benchmarks for mortgage and other important financial rates. Currency futures should not be confused with spot forex trading, which is more prevalent among individual traders. A commodity is a physical product whose value is determined primarily by the forces of supply and demand. This includes grains (corn, wheat, etc.), energy (such as natural gas or crude oil), and precious metals like gold or silver. A forward contract is the oldest type of these agreements, predating the trading in futures that formalized “to arrive” contracts in the latter half of the 19th century.
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Key futures markets include stock indexes, energy, currencies, cryptocurrencies, interest rates, grains, forests, and livestock. As its name suggests, a futures contract is a financial instrument through which a buyer and seller agree to transact an asset at a fixed price at a future date. Despite a futures contract providing the opportunity for the delivery of an asset, most don’t result in physical delivery but are rather used by investors to speculate on a security’s price or hedge risk in a portfolio. Physical delivery is standard for commodities like oil, gold, or wheat. However, for futures contracts based on stocks and stock indexes, the settlement method is cash. Futures and options are derivatives, financial instruments derived from the value of underlying assets like commodities, currencies, or indexes.
Trading futures instead of stocks provides the advantage of high leverage, allowing investors to control assets with a small amount of capital. Additionally, futures markets are almost always open, offering flexibility to trade outside traditional market hours and respond quickly to global events. These are futures traders who aim to profit from price moves, betting that price will move in a direction favorable to their trades. Speculators do not intend to take delivery of the physical goods, if any are involved in the first place. Futures speculation adds greater liquidity to the market since more parties are buying and selling. If the amount drops below the maintenance margin, e.g., if the price goes against the trade, the broker will send a margin call to the trader, requiring them to deposit more money to reach the initial margin level again.
Monitor and close your position
It’s a form of equity compensation, a popular form of employee compensation as employee stock options (ESOs). If you plan to begin trading futures, be careful because you don’t want to have to take physical delivery. Most casual traders don’t want to be obligated to sign for receipt of a trainload of swine when the contract expires and then figure out what to do with it.
This tool helps you spot developing price swings by automatically populating charts with relevant technical patterns. We offer standard, trailing and guaranteed stops,5 and you can set your stops and limits to exit a trade directly from the deal ticket. You can also set or adjust these exit levels after you’ve placed your trade. Going long means that you’re speculating on the value of a future’s underlying increasing; going short means that you’re speculating on its value decreasing. Now that we’ve seen what futures are, let’s explore how they work by defining and illustrating some essential futures terms. Get a custom financial plan and unlimited access to a Certified Financial Planner™ for just $49/month.
The key difference lies in the obligations they impose on buyers and sellers. The range of assets underlying futures covers everything from agricultural products to financial indexes. As insurance premium definition of early 2024, the most traded futures were in equities (65% of futures trading by volume), currencies (9%), interest rates (9%), energy (5%), agriculture (4%), and metals (4%).
The futures markets are regulated by the Commodity Futures Trading Commission (CFTC). The CFTC is a federal agency created by Congress in 1974 to ensure the integrity of futures market prices, including preventing abusive trading practices, fraud, and regulating brokerage firms engaged in futures trading. Futures contracts can be an essential tool for hedging against price volatility.
Developing a Futures Trading Plan
Stock futures have specific expiration dates and are organized by month. For example, futures for a major index like the S&P 500 might have contracts expiring in March, June, September, and December. The contract with the nearest expiration date is known as the “front-month” contract, which often has the most trading activity. As a contract nears expiration, traders who want to maintain a position typically roll over to the next available contract month.
In futures trading, traders only need to post a margin, a fraction of the contract’s total value. If the initial margin is 10% of the contract’s value, the trader deposits only $25,000 (10% of $250,000) to enter the futures contract. If the index falls by 10% to 4,500 points, the value of the futures contract decreases to $225,000 (4500 points x $50). Traders face a loss of $25,000, which equals a 100% loss on the initial margin. Futures trading commonly refers to futures whose underlying assets are securities in the stock market. These contracts are based on the future value of an individual company’s shares or a stock market index like the S&P 500, Dow Jones Industrial Average, or Nasdaq.
NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments. Andrew is a writer with more than two decades of investing experience and a B.A. Andrew believes in combining technical analysis, fundamental analysis, and strict risk management principles to formulate his decisions. He has held various positions in the financial industry, including stock strategist, Senior Manager of Educational Content, and portfolio manager.
The brokers only ask for part of the initial investment, a fraction of the contract’s total value, usually 3% – 10%, called the initial margin. The trading provider or broker would loan the rest to complete the total contract value. Even experienced investors will often use a paper trading account to test a new strategy. Some brokers may allow you access to their full range of analytic services in the paper trading account. The investing information provided on this page is for educational purposes only.
Futures trading offers traders the opportunity to control positions using an amount of capital known as margin. This leverage can lead to increased profits if the market moves in the trader’s favor. Options and futures are complex instruments which come with a high risk of losing money rapidly due to leverage. Before you invest, you should consider whether you understand how options and futures work, the risks of trading these instruments and whether you can afford to lose more than your original investment.
NerdWallet, Inc. is an independent publisher and comparison service, not an investment advisor. Its articles, interactive tools and other content are provided to you for free, as self-help tools and for informational purposes only. NerdWallet does not and cannot guarantee the accuracy or applicability of any information in regard to your individual circumstances.
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