What Are Futures Contracts?
Futures contracts bind two parties, a buyer and a seller derivatively, to trade an asset at a predetermined current price until a specified future date regardless of the current market price. Futures contracts can be used by a variety of traders which include investors and speculators, as well as companies that want to physically deliver or supply the commodity. Futures allow investors and traders to profit from price speculation, hedging and arbitrage. It is primarily intended for market participants to use in order to reduce the risk of future price changes in an asset.
Futures contract is different from Options contract, options contract, involves both a buyer and a seller. Options can lose their value when they expire, but in futures, when a contract expires, the buyer is obliged to purchase and receive the underlying asset, and the seller is obliged to provide and deliver the underlying asset.
Buyers of both options and futures contracts benefit from a leverage holder's position closing before the expiration date in this manner. Futures market trading serves two primary purposes, price speculation, price speculation ensures investors make a profit and hedging, hedging ensures traders minimize losses.
Futures contracts facilitate futures trading, which is commonly used by individual traders to profit or by corporations to lock in the prices of commodities required for production and manufacturing. Futures are traded in varieties of assets like cryptocurrencies, stocks, commodities, indices and currency pairs.
Characteristics of Futures Contracts
Futures contracts are tradable:
- Futures contracts are regularised
- Futures contracts are standardized
- Futures contracts are derivatives, it’s the price is based on the price of the underlying asset
- Futures contracts are an obligation, upon the expiration of the futures contract, the buyer is obligated to receive the assets at the agreed-upon time and price, and the seller is obligated to contribute the desired assets.
- Futures contracts are time-bound
- Futures contracts are mostly settled by regulating bodies
What is Futures Trading
Futures trading is a method of speculating on or hedging against the future value of various assets, such as cryptocurrency, bonds, stocks, forex and other commodities. The futures price of a cryptocurrency, bonds, stocks, forex and other commodities are leveraged when traded over a period of time. You can leverage more when trading futures compared to trading stocks, crypto and other tradable commodities on spot, allowing for very high returns, but it is also very risky and you can get liquidated.
Futures are usually traded by brokers.
Futures Brokers
A broker is an individual or company that organizes and executes financial transactions on behalf of another party. Brokers carry out transactions such as stock purchases and sales on behalf of their clients. They are varieties of assets tradable on brokers, examples are cryptocurrency, forex, stocks, real estate, and other tradable commodities. Brokers usually charge commissions for the order to be executed.
Difference between Broker, Stockbroker and Brokerage
Broker
A broker is simply someone who purchases and sells goods or assets on behalf of others. A broker can be an individual or a company who acts as a trusted agent or intermediary in commercial negotiations or transactions. Brokers are typically licensed professionals or organizations who work in fields requiring specialized knowledge, such as finance, insurance, and real estate. A brokerage is a term used to describe their rate of pay. The brokerage is determined by trade custom or by law, and it is commonly calculated as a fixed percentage of the transaction amount (value) or on a sliding scale.
Stock-broker
A stockbroker, also known as an authorized, licensed representative, is an investment professional who executes market orders on clients' behalf. Stockbrokers are registered representatives who work for brokerage firms and handle transactions for retail and institutional clients. Brokerage firms and broker-dealers are also known as stockbrokers. Online discount brokers are used now for the majority of buy and sell orders. These processes are usually automated thus the fees are reduced.
Full-service brokers are mostly used by rich individuals and organizations, who provide advice and portfolio management services in addition to transaction execution. Stockbrokers serve as intermediaries for markets and traders or investors. Brokers accept customer orders and attempt to fill them at the lowest possible price. As a result, they receive a commission known as a brokerage.
Brokerage
When you buy or sell an asset/stocks or anything through a broker, the broker charges a commission for the transaction, which is known as brokerage.
Futures Terminologies
Trading Cycle:
A trading or contract cycle is the length of time that a futures contract is traded on a broker exchange. The expiration date for all futures contracts is specified. Traders have several options before the expiration date to either close out or extend. The broker settles the trader after the expiration date and the trader closes out his/her trade. Settlement is the fulfillment of the original contract's legal delivery obligations.
Lot Size:
A futures contract is a standardized contract with specific parameters. The lot size, market lot, or contract size is one such specification. A lot size is the smallest number of units or ticket size of shares that can be traded in futures. A lot size is simply the minimum number of units or shares that must be purchased or sold under a contract. The lot size varies depending on the derivative contract.
Expiration Date:
The expiry date is the date by which the buyer and seller of a futures derivative contract must honor their contractual obligations. On or before this date, investors or traders in a futures contract will have made the decision on what to do with their expiring position.
Mark-to-Market:
Mark-to-market also known as “MTM” is a method of evaluating assets based on their most recent market price. Gains and losses are settled on each trading day, which is an important feature of futures contracts. This means that the contract's value is marked to its current market value.
Summary
In summary, trading futures is considered "risky" because a trader can easily be liquidated, but trading futures can be profitable depending on the trading strategy used and the trader's experience. A trader's success in futures trading is determined by his trading strategy, experience, and, most importantly, how he combines these. A good strategy and proper execution can help a futures trader become a profitable futures trader. Futures trading incorporates both fundamental and technical analysis.
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