Trading Academy
Capitalco serves customers around the world as an introducing broker of FxPro with a global product line based on the most innovative online trading experience by offering superior trading environment and a wide range of educational materials
Futures
What is a Future Contract ?
A futures contract or “futures” is a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future. Futures contracts are standardized for quality and quantity to facilitate trading on a futures exchange.
The buyer of a futures contract is taking on the obligation to buy and receive the underlying asset when the futures contract expires. The seller of the futures contract is taking on the obligation to provide and deliver the underlying asset at the expiration date.
Key Takeaways
✓ Futures contracts are financial derivatives that oblige the buyer to purchase some underlying asset (or the seller to sell that asset) at a predetermined future price and date.
✓ A futures contract allows an investor to speculate on the direction of a security, commodity, or financial instrument, either long or short.
✓ Futures are also often used to hedge the price movement of the underlying asset to help prevent losses from unfavorable price changes
Basics of Futures Contracts
Futures are derivative financial contracts that obligate the parties to transact an asset at a predetermined future date and price. Here, the buyer must purchase or the seller must sell the underlying asset at the set price, regardless of the current market price at the expiration date.
Underlying assets include physical commodities or other financial instruments. Futures contracts detail the quantity of the underlying asset and are standardized to facilitate trading on a futures exchange. Futures can be used for hedging or trade speculation.
Example of Futures Contract
Futures contracts are used by two categories of market participants: hedgers and speculators.
An oil producer needs to sell its oil. They may use futures contracts to do it. This way they can lock in a price they will sell at, and then deliver the oil to the buyer when the futures contract expires. This way they know in advance the price they will pay for oil (the futures contract price) and they know they will be taking delivery of the oil once the contract expires.
Contracts are standardized. For example, one oil contract on the Chicago Mercantile Exchange (CME) is for 1,000 barrels of oil. Therefore, if someone wanted to lock in a price (selling or buying) on 100,000 barrels of oil, they would need to buy/sell 100 contracts. To lock in a price on one million barrels of oil/they would need to buy/sell 1,000 contracts.
Mechanics of Futures Contract
Futures contracts are used by two categories of market participants: hedgers and speculators.
An oil producer needs to sell its oil. They may use futures contracts to do it. This way they can lock in a price they will sell at, and then deliver the oil to the buyer when the futures contract expires. This way they know in advance the price they will pay for oil (the futures contract price) and they know they will be taking delivery of the oil once the contract expires.
Given the volatility of oil prices, the market price at that time could be very different than the current price. If the oil producer thinks oil will be higher in one year, they may opt not to lock in a price now. But, if they think $75 is a good price, they could lock in a guaranteed sale price by entering into a futures contract.
Regulations of Futures
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 pricing, including preventing abusive trading practices, fraud, and regulating brokerage firms engaged in futures trading.
Trading of Futures Contracts
Traders and portfolio managers are interested in a profit on the price movements of oil. Futures contracts can be traded purely for profit, as long as the trade is closed before expiration. Many futures contracts expire on the third Friday of the month, but contracts do vary so check the contract specifications of any and all contracts before trading them.
For example, it is January, and April contracts are trading at $55. If a trader believes that the price of oil will rise before the contract expires in April, they could buy the contract at $55. This gives them control of 1,000 barrels of oil. They are not required to pay $55,000 ($55 x 1,000 barrels) for this privilege, though. Rather, the broker only requires an initial margin payment, typically of a few thousand dollars for each contract.
The final profit or loss of the trade is realized when the trade is closed. In this case, if the buyer sells the contract at $60, they make $5,000 [($60-$55) x 1,000). Alternatively, if the price drops to $50 and they close out the position there, they lose $5,000.
Trading of Futures Contracts
Traders and portfolio managers are interested in a profit on the price movements of oil. Futures contracts can be traded purely for profit, as long as the trade is closed before expiration. Many futures contracts expire on the third Friday of the month, but contracts do vary so check the contract specifications of any and all contracts before trading them.
For example, it is January, and April contracts are trading at $55. If a trader believes that the price of oil will rise before the contract expires in April, they could buy the contract at $55. This gives them control of 1,000 barrels of oil. They are not required to pay $55,000 ($55 x 1,000 barrels) for this privilege, though. Rather, the broker only requires an initial margin payment, typically of a few thousand dollars for each contract.
The final profit or loss of the trade is realized when the trade is closed. In this case, if the buyer sells the contract at $60, they make $5,000 [($60-$55) x 1,000). Alternatively, if the price drops to $50 and they close out the position there, they lose $5,000.
The Bottom Line
A futures contract gets its name from the fact that the buyer and seller of the contract are agreeing to a price today for some asset or security that is to be delivered in the future.
Futures are a popular investment method for traders around the world as it allows the speculation on the value of a range of commodities, indices and energies provided by FxPro.
