Futures 101

Introduction to Futures Trading

Futures Contracts are standardized legal agreements to buy or sell an asset at a predetermined price at a specified time in the future. Futures are traded on exchanges and can involve commodities, indices, currencies, and more.

How the Futures Market Works

• Standardization: Contracts are standardized in terms of quality, quantity, and delivery time.

• Margin Requirements:

  • Initial Margin: A percentage of the contract's value required to open a position.

  • Maintenance Margin: The minimum account balance required to keep a position open.

• Mark-to-Market: Daily settlement of profits and losses based on market movements.

Key Concepts in Futures Trading

• Underlying Assets:

  • Commodities: Oil, gold, agricultural products.

  • Financial Instruments: Stock indices, currencies, bonds.

• Contract Specifications:

  • Contract Size: Amount of the underlying asset.

  • Tick Size: Minimum price movement.

  • Expiration Date: The date when the contract must be settled.

• Delivery vs. Cash Settlement:

  • Physical Delivery: Actual exchange of the underlying asset.

  • Cash Settlement: Payment of the difference between the contract price and market price at expiration.

Market Participants

• Hedgers: Use futures to mitigate risk from price fluctuations in the underlying asset.

• Speculators: Aim to profit from market movements without any interest in the underlying asset.

• Arbitrageurs: Exploit price differences between markets for profit.

Fundamental Analysis in Futures

• Supply and Demand Factors:

  • Weather Conditions: Affect agricultural commodities.

  • Economic Indicators: Influence financial futures like indices and currencies.

  • Global Events: Geopolitical tensions can impact commodity prices.

• Reports and Data Releases:

  • Energy Information Administration (EIA) Reports: Affect oil and gas futures.

  • Crop Reports: Influence agricultural futures.

Technical Analysis in Futures

• Volume and Open Interest:

  • Volume: Number of contracts traded during a period.

  • Open Interest: Total number of outstanding contracts not settled.

  • • Interpretation: Increasing open interest suggests new money entering the market, indicating strength.

• Price Patterns:

  • Contango: Futures price is higher than the expected future spot price.

  • Backwardation: Futures price is lower than the expected future spot price.

Advantages of Futures Trading

• Leverage: Control large contract values with relatively small capital.

• Liquidity: Many futures markets are highly liquid.

• Transparency and Regulation: Exchanges enforce standardized contracts and clear regulations.

• Diversification: Access to a wide range of markets and assets.

Risks in Futures Trading

• High Leverage Risk: Can lead to substantial losses exceeding the initial investment.

• Market Volatility: Prices can change rapidly due to various factors.

• Margin Calls: If the account balance falls below the maintenance margin, additional funds are required.