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What Is a Futures Contract?

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Futures contracts are a true hedge investment and are most understandable when considered in terms of commodities like corn or oil. For instance, a farmer may want to lock in an acceptable crop price in case market prices fall before the crop can be delivered. The buyer also wants to lock in a price to protect against a subsequent rise in prices. Options and futures are two varieties of financial derivatives investors can use to speculate on market price changes or to hedge risk.

  1. NerdWallet, Inc. is an independent publisher and comparison service, not an investment advisor.
  2. This is an invaluable way to check your understanding of the futures markets and how the markets, leverage and commissions interact with your portfolio.
  3. E-mini futures contracts trade from Sunday evening through Friday afternoon, offering traders nearly continuous market access during the business week.

Due to leverage, which means using debt or borrowed money for trading, investors risk losing more money – profits are amplified, but so are losses. This guide will explain the basics, including what futures are, how they work, and its benefits and risks. Because of the nature of these contracts, forwards are not readily available to retail investors. That’s because the agreements and their details are generally kept between the buyer and the seller, and are not made public.

If they think rates will drop, for instance, then they may buy a futures contract for bonds (because bond prices rise when interest rates fall). If the trader thinks that stocks will rise, they may buy futures corresponding to the S&P 500. The role of the futures exchange is similar to the role of a stock exchange. Just like with stock trading, exchanges provide a safe and efficient place to trade futures.

Futures are contracts where the buyer agrees to buy a commodity or financial instrument at a particular quantity, price, and date at a later point in time — and the seller agrees to sell or deliver the asset. Futures are derivatives, which means that their value is derived from an underlying asset. For example, a futures contract on crude oil will be heavily influenced by the price fluctuations of the oil market. But if you’re pessimistic about a company’s outlook, you may consider put options instead. Then there are futures contracts, which are another financial tool that traders can use to speculate on the price swings of assets like oil, gold, and other commodities. A futures contract is the obligation to sell or buy an asset at a later date at an agreed-upon price.

What to know about futures contracts — and the 5 reasons investors trade them

To hedge the risk, in July, he sells short a number of December corn futures contracts roughly equal to the size of his expected crop. Imagine a trader who has a $5,000 brokerage account balance and has a $50,000 position in crude oil. If the price of oil moves against the trade, it can mean losses that far exceed the account’s $5,000 initial margin amount. In this case, the broker would make a margin call requiring that additional funds be deposited to cover the market losses.

Their only interest is to earn a profit from trying to predict the price changes, which is why they close their positions before the futures contracts expire. Futures traders must post an initial margin requirement, also known as a performance bond. These are good-faith deposits compelling each party in a trade to meet their obligations.

The clearing house becomes the buyer to each seller, and the seller to each buyer, so that in the event of a counterparty default the clearer assumes the risk of loss. This enables traders to transact without performing due diligence on their counterparty. In this scenario, the investor holding the contract upon expiration would take delivery of the underlying asset. They’d be responsible for the goods and covering costs for material handling, physical storage, and insurance. The difference between the prices would be cash-settled in the investor’s brokerage account, and no physical product would change hands. However, the trader could also lose if the commodity’s price was lower than the purchase price specified in the futures contract.

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The company tends to work alongside asset management firms and hedge funds. All strategies have ups and downs, but you should decide which one you want to go with and define it for your futures trading. If such risk seems too much and you’re looking for a way to shake up your investment strategy, consider trading options instead. For instance, their details are not euro vs.dollar history made public, as they are negotiated privately between the two parties involved and because they trade over the counter. As such, these derivatives aren’t regulated and come with a greater degree of risk. In effect, forward contracts have more exposure to “counterparty risk,” which refers to the chance that one party might refuse to fulfill their side of the deal.

This can amplify potential gains, but it can also increase the risk of significant losses if the price of the underlying asset moves against the trader’s position. Futures contracts are traded on organized exchanges, such as the Chicago Mercantile Exchange (CME) or the New York Mercantile Exchange (NYMEX), and their prices are determined by supply and demand in the market. Prices fluctuate based on a variety of factors, including supply and demand for the underlying asset, geopolitical events, and economic indicators. For speculators, futures offer more ways to diversify than investing in stocks. They give uninterrupted exposure to the prices of the underlying assets to commodities like gold or oil, unlike stocks, where many other market factors are in play and affect the share prices.

How do futures exchanges work?

Some U.S. exchanges also use the term “maintenance margin”, which in effect defines how much the value of the initial margin can reduce before a margin call is made. However, most non-US brokers only use the term “initial margin” and “variation margin”. Margin calls are usually expected to be paid and received on the same day. If not, the broker has the right to close sufficient positions to meet the amount called by way of margin.

Currency futures

Here are some other major differences between these two financial instruments. Jones (6-2, 225) originally entered the NFL as an undrafted free agent with the Seattle Seahawks in 2022 after playing his college ball at USC and North Carolina State. He spent most of his rookie season on the Seahawks’ practice squad but was elevated for game day three times and appeared in three contests, playing on special teams. He went back to training camp in Seattle this past summer but was waived with an injury settlement at the end of the preseason. In his two seasons at NC State, Jones tallied 80 tackles, 9.0 sacks, 13 tackles for loss and five forced fumbles in 23 games. Futures contracts offer the possibility to manage risk by anticipating upcoming events that can change market prices.

If you’re just getting started, we highly recommend spending some time trading in a virtual account until you’re sure you have the hang of it. Keep up with the terminology, news and events investors https://bigbostrade.com/ should know about with our monthly market newsletter. We’re transparent about how we are able to bring quality content, competitive rates, and useful tools to you by explaining how we make money.