A futures contract is a standardized agreement for purchasing and selling a commodity at a future date. Futures contracts are traded on an exchange and can be traded through a broker.

The price of the futures contract is based on the price of the underlying commodity and the fluctuating market price of the commodity.

The buyer of the futures contract pays a premium to the seller for the right to buy the underlying commodity at a known price on a specific date in the future.

When the contract expires, the contract is closed, and the buyer and seller both get back the amount they paid for the contract. Learn more about futures trading.

Futures Contract

A futures contract is when two parties sign an agreement to buy or sell an asset at a specific price on a future date. For example, one party agrees to purchase an asset on a specific date, while the second party agrees to sell the asset on the date decided. The two parties already agree upon the price of the asset.

Usually, these agreements take place over standard commodities such as:

Bonds
Oil
Gold
Wheat
Price of a stock index

The futures agreement is always made on commodities that are regulated. However, one thing that is important to keep in mind is that some commodities (oil, gold, wheat) can be delivered, whereas other commodities (index futures) can be converted into cash.

Typical Users of the Futures Market

Most participants in the Futures market are either consumers or producers of institutional or commercial commodities.
Most participants in the futures market are usually Hedges, who trade futures to increase the value of their assets and reduce their losses caused by changes in price.
Some participants in the futures market are speculators, who profit from the changes in the price of futures contracts.

Regulations in the Futures Market

Individuals and companies giving trading advice and handling customer funds must register with the NFA (National Futures Association), a regulatory organization that CFTC approved.
The CFTC gives customers protection by requiring:
Past performance and market risks need to be disclosed by the customers
Customer funds must be in a separate account rather than the company’s account
Accounts of the customer must be adjusted to reflect trading day market value
The CFTC also monitors: internal controls, registrant supervision systems, and sales practice compliance programs
The NFA gives details to all the traders; visit their website for more information

Advantages of Futures Contracts

The Market Attracts Investment

Futures contracts are beneficial for investors that can tolerate risks. Therefore, these investors are attracted to the Futures market.

Margin Requirements are Stable

Margin requirements for currencies and commodities in the Futures market are pre-determined. This helps the trader know the amount of margin he needs to put up in a contract.

No Involvement of Time Decay

In Options trading, time decay has a key role, and the value of assets declines over time. However, there is no time decay in the Futures market, so traders have nothing to worry about.

Liquidity is high

Most Futures markets in the world have high liquidity, especially for commodities, currencies, and indexes. This gives the trader the luxury of entering and leaving the market on their terms.

Simple Pricing

Futures pricing is easy to grasp and is based on a cost-carry model. This model states that the price in the Futures market is determined by adding carrying cost to the asset spot price.

Protection against Fluctuations in Price

Forwards contracts are also used as tools for hedging, especially in industries where there are price fluctuations. Farmers use these contracts to avoid losses from a decrease in the price of crops. For instance, if a farmer is planting wheat and is expecting to harvest almost 8,000 bushels.

At the harvest time, the farmer may be unsure of the price, so that he might sell the entire crop at a fixed price before the harvest. The payment will be made five months after the contract is signed. Although the farmer isn’t paid instantly, the contract protects him from price fluctuations.

Hedging Against Future Risks

Many traders enter the Futures market because of better risk management. Companies also use Future contracts to protect themselves from foreign exchange risks.

Dis-Advantages of Futures Contracts

There is no control over Futures Events.

One major drawback of the Futures market is that traders have no control over future events. Unpredictable events such as:

Political issues
Dangerous weather
Natural disasters

These events can completely disrupt the equilibrium of the Futures market.

Issues of Leverage

When leverage is high, it can lead to rapid price fluctuations; the price can rise or regularly decline, even within minutes.

Date of Expiry

Futures contracts involve a date of expiry, and the asset price can become unattractive as the expiration date approaches. This means that on rare occasions, a Futures contract may expire and be considered a useless investment.

How Much does it Cost to Trade Futures?

The commission for futures trading can vary. For example, on some commodities, the commission is only $1, whereas, on other commodities, the commission can be as high as $ 10% per contract, especially when trading Bitcoin Futures.

Apart from commissions, there are other costs; some brokers will charge an additional monthly market data and trading platform fee. In addition, each broker requires a specific deposit from traders to trade Futures contracts. Usually, the minimum deposit is $ 1000.

How to Calculate Margin in Futures Trading?

To meet the margins requirement, traders must ensure sufficient capital in their trading accounts before their position opens up. The requirement of margins is usually a percentage of the underlying value under each contract.

For example, if a trader wants to speculate an increase in the March 2021 wheat contract price, he will need to open a buy-to-open account. The specifications of the contract state that a contract controls over 5,000 bushels of wheat (136 metric tons), each bushel as of January 2021 costs $ 6.53.

The underlying 5000 wheat bushels X price of each bushel ($ 6.53) equals $ 32,650; this figure is the trade value. Therefore, 5 % of the trade value will be the margin, which is $ 1,650.

Best Futures Trading Brokers and Platforms

Forex

Pros

Great mobile and desktop functions
Trading view charts are available
Safe and is regulated by top regulators

Cons

It has a higher spread than rival platforms
There is no negative balance protection
No cryptocurrency trading in the United States

IG

Pros

Regulated by several authorities (FCA, ASIC, and CFTC)
Deposit of $ 250 (minimum)
Rates are competitive
More than 16,000 markets

Cons

High monthly inactivity fee after two years
High stock CFD charges

CMC Markets

Pros

Pricing is competitive
Large selection of products, quality is high
Safe, regulated by top authorities
No charges for opening an account

Cons

No fixed spread accounts
Few security features
No platform for social trading

Saxo

Pros

Award-winning platform
Good reputation
Transparent in finances
User-friendly interface

Cons

Fees are high
Poor customer support

What is an Option?

Generally, options are of two types: a put and a call. It is important to understand the difference between options, allowing you to use them better. When someone buys an option, they have to pay a premium to the seller. Although this is not considered an obligation, this payment will give the buyer the right to buy or sell the underlying assets.

Similarly, there are two major components for options trading: a buyer and a seller. Traders willing to bear the risk sell a significant amount of options, and they collect a premium on it. However, the traders’ premium is considered a liability in most cases unless the options either expire or are bought back.

Call Options

Call options allow the buyer to have the right to buy an underlying asset at a certain strike price and within a specific time. The seller must deliver a long position in underlying contracts in the future if the buyer decides to exercise the call option. If the call option expires, the seller will be forced to take a short position in the market.

Put Options

Put options allow the buyer the right to sell underlying assets at a certain strike price within a specific time. If the buyer chooses to exercise the option, the seller must deliver a short position from the strike price.

Differences between Futures and Options

Futures and Options are derivatives and have several applications such as arbitrage, hedging, and trading. However, options might also be considered portfolio insurance, and traders usually write options against stock positions that they are uncertain about.

Traders also invest in options to hedge against the downturns in the markets. But, on the other hand, Futures are there to allow vendors, producers, and consumers to hedge the inventory and productions by locking in the current price in the market, but only if it is profitable for them.

Basics of Currency Futures

The practice of betting on currency futures first took place in Chicago, at the Mercantile Exchange, in 1972. As stated earlier, Forex is the biggest financial market globally, thousands of corporations and individuals are involved in the trading, and new currency futures contracts are made daily.

However, before they indulge in currency futures, traders must have sufficient capital in their trading account. The margin of profit of loss in currency futures is slim, as the currency’s price might fluctuate. The best strategy to apply is to close all trades before the expiration date by either selling or buying more currencies.

Some currencies have different future contract rules, such as the South African rand and Mexican Peso. These currencies only allow futures forecast four times a year. Let’s explain currency futures with the help of an example:

If traders buy Euro Forex futures by using the US dollar and signing a futures contract (exchange ratio is 1 EUR: 1:20 USD), the traders will receive the total amount of 12,500 Euros, as that’s how much each Euro futures is worth.

Once the trade has been made, the traders will need to pay the seller using the USD, and in return, they will get Euros. In simpler words, the traders set the expiration date and the price, and the date is set in stone.

Currency Futures Contracts

When trading currency futures, there are many varieties of contracts available. The most commonly used contract is the EUR and USD futures, but traders can also trade the E-Micro Forex futures contracts that allow 1/10^th of the currency futures contract size.

There are also futures in which clients sell or buy several currencies at a time. It is also essential to know that the number of contracts depends on liquidity; since EUR/USD trades are most popular, over 400,000 contracts are made every day.

Currency Futures Exchange

Forex market futures are traded in exchanges that are regulated and have a stated price. This also means that all the markets offer a stable price and safe conditions. For example, the CME Group offers up to 49 currency futures contracts and has a liquid of over a billion dollars every day.

Best Futures to Buy

Eurodollar Futures

Eurodollar Futures are the most commonly traded worldwide, as they provide a cost-effective and valuable financial instrument that hedges fluctuations in the US interest rates. Eurodollars are American dollars that are deposited to foreign commercial banks. Some benefits of foreign commercial banks are:

Price transparency
Low transaction cost
Diverse opportunities to trade
Unsurpassed liquidity

Today, more than 98 % of Eurodollar Futures are traded electronically on the global index platform of CME.

E-Mini and 500 Futures

The E-Mini and 500 Futures are represented by a ticker symbol and are great if you want to add or manage exposure to large-capital firms in the US stock market. These Futures are a liquid, efficient and cost-effective way of gain market exposure in the S&P 500 index, which tracks more than 500 large US companies. Some benefits are:

Execution is flexible
Liquidity is deep
Allows you to trade a global equity index portfolio

Crude Oil Futures

Crude oil futures are an efficient way to trade in the oil markets worldwide. For example, the NYMEX WTI (the most commonly traded contract for crude oil) trades more than 1.2 million contracts daily. A single contract is equal to a thousand barrels of crude oil.

One crude oil futures contract has a value of $ 44,740. The NYMEX WTI will also give you exposure into the oil market; however, you can only trade Crude oil futures if you are the following:

Hedger: The crude oil futures can help reduce the impact of price changes on oil-related assets.
Speculator: Crude oil futures can be used to seek profits from your view of the oil price direction.

Skills needed to become a Futures Trader

Generally speaking, becoming a Futures trader is quite straightforward as you really need is a computer, a reliable internet connection, and capital for investment. However, become a futures trader does not guarantee you any success.

Studies have shown that more than 75 % of beginners in the Futures market quit in less than two years. The most common reasons for quitting are poor emotional behavior, lack of capital, and market knowledge.

With so many people failing, how do traders even succeed in such a vicious market? However, it is possible to become a successful trader in the Futures market; all you need to do is learn and master a few skills to achieve success and longevity.

Below are some important skills that traders in the Futures market need to have to succeed:

Analytical Skills

The landscape of the Futures market is rapidly evolving; it hardly ever stays constant, so a Futures trader needs to have a high-level observation to understand the changes in the market and act abruptly.

Some good analytical skills are:

Technical analysis: This analysis is the ability to consume information from charts and make sense of it. This analysis also means you should be able to study the price changes and apply real-time indicators.
Fundamental analysis: It is important to have a fundamental understanding of the Futures market, as this can give you vivid insight into the factors that influence the market price and the motivation of the competitors.
Arithmetic: Computers are more than capable of solving all types of calculations; however, it is important to have strong calculation skills to derive position sizing, stop losses and profit targets.

Have Control over your Emotions

Several factors contribute to the psychology of an individual. An individual’s approach to money can also influence performance. Traders must be in complete control of their emotions at all times, as that is the only way they will succeed.

Follow these tips:

Honesty: Unbiased self-assessment regularly can help eliminate mistakes and stop you from committing those mistakes in the future.
Suitability: The trading style you adopt must suit your personality, and you should also identify your pros and cons as a trader.
Knowing when to stop: Traders need to stop and take a break from the market, and the strategy could also lead to long-term success. Risk-taking, Over-trading, and poor capital management are caused by emotional trading, and a break can eliminate all these issues.

Computer Literacy

The futures market in the modern era is digital, and new participants are entering the market daily through the internet. However, traders will not succeed in the market without proper knowledge of computers, trading software, and how they work.

Software and Computer selection: Try to buy useful and efficient hardware or sign up with a reputable trading platform.
Troubleshooting: There will always be issues with technologies; after all, nothing is perfect or long-lasting. However, traders must be skilled enough to deal with troubleshooting errors. Some common troubleshooting errors are:
Poor computer performance
Poor internet connection
Incompatible software

Conclusion

The Futures market might have some advantages over other markets, but it isn’t easy to succeed. In this article, we have discussed several aspects of the futures market and compared Options and Futures.

All the relevant information is here; read it all up, and if you plan on doing Futures trading, then make sure you design a strategy that you can sustain in the long run.