What is Futures Trading?
Futures trading involves standardized contracts that obligate parties to buy or sell an asset at a predetermined price on a specific future date. These contracts are traded on regulated exchanges and serve two primary purposes: risk management (hedging) and speculation.
Unlike spot trading where assets are exchanged immediately, futures allow participants to lock in prices today for transactions that will occur in the future, providing price certainty and risk management capabilities.
How Futures Contracts Work
Contract Mechanics
Futures contracts are standardized agreements with specific terms set by the exchange.
Key Contract Elements:
- • Underlying Asset: What will be delivered (oil, gold, S&P 500, etc.)
- • Contract Size: Quantity of the underlying asset
- • Delivery Date: When the contract expires
- • Price: Agreed-upon price for future delivery
- • Settlement Method: Physical delivery or cash settlement
Futures Trading Example
Crude Oil Futures Contract:
Contract Details:
- • Asset: Crude Oil (WTI)
- • Size: 1,000 barrels
- • Current Price: $75/barrel
- • Contract Value: $75,000
- • Margin Required: ~$3,000
Profit/Loss Scenario:
- • Buy at $75, oil rises to $80
- • Profit: ($80-$75) × 1,000 = $5,000
- • Return: $5,000/$3,000 = 167%
- • High leverage amplifies gains/losses
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Types of Futures Contracts
Commodity Futures
Energy
Crude oil, natural gas, heating oil, gasoline
Metals
Gold, silver, copper, platinum, palladium
Agriculture
Corn, wheat, soybeans, cattle, coffee
Financial Futures
Stock Indices
S&P 500, NASDAQ, Dow Jones, Russell 2000
Interest Rates
Treasury bonds, notes, Eurodollar
Currencies
EUR/USD, GBP/USD, JPY/USD, Bitcoin
Contract Specifications
| Futures Type | Typical Size | Margin ($) | Tick Value |
|---|---|---|---|
| E-mini S&P 500 | $50 × Index | $13,200 | $12.50 |
| Crude Oil | 1,000 barrels | $3,000 | $10.00 |
| Gold | 100 oz | $8,800 | $10.00 |
| 10-Year Treasury | $100,000 | $1,800 | $15.625 |
Futures Trading Strategies
Hedging Strategies
Hedging uses futures to reduce price risk for businesses and investors with exposure to underlying assets.
Long Hedge (Buy Futures)
- • Protects against rising prices
- • Used by buyers of commodities
- • Airlines hedging fuel costs
- • Manufacturers securing raw materials
Short Hedge (Sell Futures)
- • Protects against falling prices
- • Used by producers of commodities
- • Farmers locking in crop prices
- • Oil companies securing revenue
Speculation Strategies
Speculators trade futures to profit from price movements without intending to take delivery.
Directional Trading
- • Long Position: Buy futures expecting price increases
- • Short Position: Sell futures expecting price decreases
- • Trend Following: Trade in direction of established trends
- • Contrarian: Fade extreme moves for reversal trades
Spread Trading
- • Calendar Spreads: Different expiration months
- • Inter-commodity: Related but different assets
- • Inter-market: Same asset, different exchanges
- • Crack Spreads: Crude oil vs. refined products
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Risk Management in Futures Trading
Key Risk Factors
Leverage Risk
- • High leverage amplifies losses
- • Margin calls can force liquidation
- • Can lose more than initial investment
- • Rapid account drawdowns possible
Market Risk
- • Price volatility and gaps
- • Liquidity constraints
- • Market manipulation concerns
- • Correlation breakdown risk
Risk Control Measures
Position Sizing
- • Risk no more than 1-2% of capital per trade
- • Calculate position size based on volatility
- • Account for margin requirements
- • Diversify across different markets
Stop-Loss Orders
- • Set stops before entering trades
- • Use technical levels for stop placement
- • Consider volatility when setting stops
- • Trail stops to protect profits
Portfolio Management
- • Monitor total portfolio risk
- • Avoid concentration in correlated markets
- • Maintain adequate margin cushion
- • Regular risk assessment and adjustment
Margin and Settlement
Margin System
Futures trading requires margin deposits to ensure contract performance and manage counterparty risk.
Initial Margin
- • Required deposit to open position
- • Set by exchange based on volatility
- • Typically 3-12% of contract value
- • Acts as performance bond
Maintenance Margin
- • Minimum equity to maintain position
- • Usually 75-85% of initial margin
- • Margin call if account falls below
- • Must restore to initial margin level
Daily Settlement
Mark-to-Market Process:
- • Positions valued at daily settlement price
- • Profits/losses credited/debited to accounts
- • Daily cash flow based on price changes
- • Eliminates credit risk accumulation
- • Margin calls issued if account below maintenance
Common Futures Trading Mistakes
Over-Leveraging Positions
Taking positions too large relative to account size, leading to margin calls and forced liquidations.
Solution: Use proper position sizing and maintain adequate margin cushion
Ignoring Contract Specifications
Not understanding contract details like delivery dates, tick sizes, and settlement procedures.
Solution: Study contract specifications before trading any futures market
Holding to Delivery
Accidentally holding contracts into delivery period without intention to take/make delivery.
Solution: Close or roll positions before first notice day for physical delivery contracts
Key Takeaways
- •Futures contracts obligate delivery at predetermined prices and dates
- •High leverage amplifies both profits and losses significantly
- •Used for both hedging risk and speculative trading
- •Daily mark-to-market settlement requires active margin management
- •Proper risk management is essential due to high leverage