What are Futures? – A deep dive into derivatives

What are futures?

Futures trading was always a hit among advanced traders (see the base scenario in Michael Lewis’ Flash Boys). As time passes, futures trading – and derivatives in general – are gaining popularity.

Keep on reading to get a better understanding of futures contracts!

What are Futures?

Definition of a futures contract

How do futures contracts work?

Futures is a collective term used for futures contracts.

Futures contracts are standardised legal agreements of a transaction between a contract buyer and a contract seller over securities, commodities (for example crude oil), or any financial instruments, at a predetermined price and time (in the future). In such an agreement, the two parties basically lock a set price and a date to exchange an asset.

A futures contract is an obligation

To trade futures contracts, there’s an important thing to know: it has an obligation. After the futures contract expires, the buyer is obligated to receive the assets at the pre-agreed time and price, and the seller has to contribute the desired assets.

A futures contract is a derivative

Futures is also a derivative, just as CFDs, or options. A derivative is a contract that derives its value from the underlying asset (a share, for example).

But they are not forward contracts, despite being closely related to them. Unlike forward contracts, futures contract trades take place on a futures exchange, not on OTC (over-the-counter) markets.

A futures contract put simply – an example

Let’s see an example for a futures contract: imagine you are in a market hall, food stalls all over, looking for 3 apples to buy. You’d like to buy apples at today’s market price. But instead of buying them today, you’d like to purchase them in a month, as you expect apples to get expensive in a month. Upon meeting a food vendor, the vendor is open to such transaction.

After the agreement, a contract is created, in which the underlying asset is 3 apples. After a month, you must buy the 3 apples, and the vendor has to sell you the 3 apples at a fixed price you have agreed on regardless of market conditions.

When do these contracts expire?

Futures contracts – if they only have an expiration date set for a specific month – would expire on the third Friday of each month. For example, a contract that has APR ’21 in its name, it would expire on the third Friday of April.

How would corn futures be delivered?

The physical delivery of any underlying commodity – crude oil, or silver futures for example – is difficult in large quantities. Certainty is key.

Futures contracts aim to seal such deals when there’s a legitimate interest. Either with a cash settlement (cash payment) or with delivering the commodity in its most real form to your “door” – aka. to a warehouse chosen by the exchange, depending on your style of trading futures.

What are Futures?

Types of futures contracts - e. g. what are stock futures?

Eg. what are stock futures?

Futures contracts come in many flavours, which is ideal for market participants. Futures products can be categorized by their underlying assets:

  • Stock futures (stock index futures)
  • Commodity futures
  • Precious metal futures
  • Currency futures
  • Bond futures

Stock index futures

This asset lets traders speculate of a future specific price for indexes, like SP500, EU50. This is the more popular approach on the futures markets.

Traders with a futures account can also have a futures position on Single Stock Futures. With SSF’s, two parties agree to a transaction on a specified date with a fixed price for on single stock, usually found on any stock market.

How to buy oil futures?

What are they? Well, collectively these futures contracts are known as commodity futures contracts. Futures on commodities are agreements on commodities like oil, coffee, natural gas, cotton, and so – instead of assets from the stock market, commodities focus on raw materials.

There are even milk futures out there! They can be either settled in cash or in their “original” form.

Metals, currencies, bonds as underlying

Precious metal futures – as their name suggests – aim at transactions, in which the underlying asset is a commonly sought-after metal, like gold, or silver.

Futures on currencies specify a price for a currency at a future date at which another currency can be bought or sold at an expected spot price after the contract’s expiration date.

And last but not least, futures on bonds are derivatives on fixed income assets, where the two parties trading futures have the obligation to buy or sell a bond (depending on which side of the contract you’re on).

Alternatively, to manage risks, futures options are popular among traders. Futures options are providing the possibility to buy a futures contract or to sell a futures contract – just as with any usual options contract.

However, they are not recommended to retail traders, as it requires a better understanding of how option trading works or what to look out for closing on the expiration date. And as always, past performance isn’t a guarantee for future results.

Fun stuff

Did you know that there are other types of futures as well? Like, soybean futures? Or even better – live cattle futures?

What are Futures?

Futures markets - where are these assets traded?

Futures markets – where are these assets traded?

To trade futures – or to buy or sell these contracts – you’d need access to a futures market. There are specific markets, which are open only for futures trading.

One of these markets is the Chicago Mercantile Exchange, part of the CME group, with an average daily volume of 20 459 thousand trades! Amazing.

CME is the most famous derivatives market (futures market) out there. Originally, it was founded in the 19th century, and today, it serves traders internationally.

Most brokers that offer access to futures trading are connected to this exchange. If you open a brokerage account for futures trading, you’ll most likely be accessing CME on the US markets.

In Europe, financial derivatives can be either traded on Euronext or ICE.

ICE Futures Europe focuses on futures on commodities and options futures contracts for crude oil, interest rates, equity derivatives, natural gas, power, coal, emissions and soft commodities, while Euronext provides access to stock and stock index futures, total return futures and more.

The volumes and prices can be tracked easily to check how volatile these markets are, as general data (not personal data) is signaled globally via third-party trading sites or brokers sites.

What are Futures?

Which authority regulates the futures markets?

When it comes to markets in any country, there’s one entity overseeing all transactions and trades. In the USA, it is the Commodity Futures Trading Commission, aka the CFTC.

The Commodity Futures Trading Commission is an independent agency, working on behalf of the government of the United States. They not only regulate the futures market within the US, but every derivative market out there, including markets dealing with options, swaps, or alternate derivatives.

In Europe however, it is completely different. Regulation is dependent on the market discussed. ICE Europe for example is regulated by the United Kingdom’s Financial Conduct Authority (FCA). Regarding Euronext, it is a co-effort by multiple EEA members. The list of regulating countries consists of Belgium, France, Ireland, Norway, The Netherlands, Portugal and the United Kingdom, each representing their own national regulating body.

What are Futures?

Futures trading with brokers

What makes a good online broker for trading futures? Which brokerage services are good for futures? First, they need to offer fair fees for buying and selling futures. To size them up in this regard, we checked the costs of stock index contracts. Second, they should offer access to a variety of exchanges (like the CME, CBOT, NYMEX, etc).

It’s also important that they have a user-friendly web and desktop platform that makes technical analysis easy. Last, but not least, we prefer brokers with great overall quality and score, for example, brokers that charge very low or no withdrawal fees, have great customer service and are safe.

Extra stuff, like having the option for a margin account for initial margin trading or the possibility to apply market research with different tools. The required margin is usually a fixed % of the futures contract.

At BrokerChooser, we have collected the best brokers for futures in the US, and also internationally. Find them by clicking the links below:

Most of the time, brokers that cover futures also cover other assets, like mutual funds, forex, stocks, bonds or any assets that are not traded without having a specified future date for its price.

What are Futures?

Difference between futures and mini-futures

Futures prices for a futures contract can be high, especially if the underlying is a stock index. This means, that a full contract can be pricey for a beginner trader. To get to know whether a contract is a full contract or a mini one, it is best to read to contract specifications to get to know the details when it comes to this asset.

There’s however an alternative product to tackle this issue called E-mini futures. E-minis are electronically traded contracts, that are a fraction of a real contract. These appeared first in the late ’90-s when the price of the SP500 stock index futures became too large. These assets are traded 24/7 non-stop and have much lower costs than regular, full-sized futures contracts.

However, exposure is much different and much less with mini-futures compared to “full-sized” futures.

For example, the E-mini futures contract of the full-sized SP500 index is one-fifth of the price of the “real” one. 

Beginner traders favour minis, as they can get into trading with much less to risk.

What are Futures?

Bottom line

Hope you have enjoyed this handy article.

Still unsure? For a tailored recommendation, check out our broker finder tool. You can enter your country and it will show only those brokers that are relevant to you. Want more details on brokers? Compare brokers with the help of this detailed comparison table.

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