Futures

Understanding Futures

What are futures?

A future or “commodity future” is an agreement that is entered between a buyer and a seller on a regulated exchange. The buyer assumes the obligation to take delivery of the commodity at a future date and pay the seller the contract price.

These contracts are usually very liquid and the obligation can be removed at will by offsetting the original future position in the listed exchange. All that is needed to enter into such a transaction is a brokerage account that’s approved to trade futures, and to deposit a fraction of the notional value of the contract, an initial margin, with your respective clearing firm.

On a daily basis positions are marked to market, and depending on the subsequent move in the value of the contract, the margin required may vary.

What are futures used for?

Futures have two main and very important uses for those involved in the commercial and financial arena: hedging (risk management) and speculation.

Hedging

Futures contracts can be bought or sold by individuals, corporations and institutional investors who are exposed by their daily activity to the price swings of a commodity (oil, corn, equity portfolio, etc.) on which they base their business.

Futures can help them mitigate the risk associated with subsequent adverse moves in the price of that commodity and its effect on their operations or investment portfolio.

Speculating

Investors and speculators can buy or sell futures to potentially profit from their views on the market. Futures can help them deploy their directional market strategies in a capital efficient manner.

Once a position is taken, speculators can, prior to expiration, easily buy or sell an offsetting futures contract position to eliminate any obligation to the actual commodity.

Why Futures?

Some Exchange Traded Funds (ETFs) and derivatives can be used to hedge and speculate future market moves, but futures contract carry distinct benefits that other instruments do not have.

Go to Risk disclaimers

Leverage

Leverage gives you the potential to generate larger returns relative to the amount of money invested, but it also puts you at risk of losing more than your original investment. Correctly managed, it may be a more efficient way to allocate capital.

Diversification

Futures markets allow you to expand your investment universe as it gives you access to a broader range of sectors and asset classes which aren’t typically found in traditional financial markets.

Short selling

Investors anticipating lower asset prices may wish to enter a short sale. Short selling occurs when an investor borrows a security, sells it on the open market, and expects to buy it back later for less money. When trading futures, short selling is not dependent on borrowing the asset one wants to short; you only need to sell the futures contract that meet your criteria, thus execution is faster and more efficient.

TRADING FUTURES, OPTIONS ON FUTURES AND SPOT ON FOREIGN CURRENCY (FOREX) INVOLVES SUBSTANTIAL RISK OF LOSS AND IS NOT SUITABLE FOR ALL INVESTORS. THEREFORE, YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION, CIRCUMSTANCES, AND INDUSTRY KNOWLEDGE. YOU MAY LOSE ALL OR MORE OF YOUR INVESTMENT.

Futures

Understanding Futures