What is a Futures Contract?
A futures contract is an agreement between two trading parties to buy and sell a financial instrument or asset at a pre-determined price. The physical exchange however of the asset and the payment between the dealer and the trader will only happen at a later time.
The logic behind agreeing on a price for an asset that will than be delivered in the future is because this type of contract is used as a hedging mechanism to protect both parties from any circumstances that could affect the price of the asset. Basically a futures contract is a ‘buy now, pay and exchange later’ type of agreement.
Normally those type of agreements are concluded on the floors of trading exchanges and there are a number of exchanges in the worlds where futures contracts are settled like for example the CME Exchange.
What is the history of Futures contracts?
Trading on futures contracts goes back to long way as the Dojima rice exchange was opened in 1697 by the Samurai in Japan. In that exchange rice futures contracts were firstly traded. At that time the rice was the measure of wealth in Japan and who had more rise had the economic control of the Japanese empire. The Samurai were the elite class of citizens at the time and the rice exchange where rice could be traded was a way to ensure the continuity of the system of wealth control in that period.
In the 19th century new futures exchanges were established in other parts of the world. In 1848 the Chicago Board of Trade (CBOT) was established and with him a new era in futures market trading. At the time the majority of futures contracts were being done on agricultural commodities and grains were the most traded commodity when the CBOT was formed. In the second part of the 19th century there were other futures markets around the USA were futures contracts were made on coffee, cotton and produce.
Over the years there were lots more futures trading markets in the world. Nowadays there are futures trading markets for lots of different assets: agricultural, metal, currencies and even bonds in most of the top financial countries like Canada, UK, Singapore, New Zealand, Japan, Australia and the US. More assets are now traded as futures and to protect the markets agencies were formed to provide regulatory oversight. One of the most famous is the Commodities and Futures Trading Commission (CFTC) which regulates the futures markets in the UK. The CFTC also work in synergy with other regulators across the world to make sure the futures markets will stay transparent and the confidence of investors will stay high.
What are the Futures Contract Industry Facts?
The CME group is that company who offers the widest range of futures contracts in the world. They do provide information about the leading futures and options contracts with their famous Leading Products Quarterly Report.
What are the most popular types of Futures Contracts?
There are lots of futures contracts traded on the many futures exchanges and below we have provided a view of what those are:
Currencies are an asset that can be traded as futures assets. This is done mostly to protect the buyers and the sellers from currency price fluctuations. Currency can fluctuate significantly and might make the deal more expensive to execute for the buyers or can cause sellers of a product to lose money. Agreeing on a currency price for a deal fur the future will ensure protection for both parties in case the currency moves significantly.
Similarly to currencies the essence of setting up futures agreements in agriculture is to protect buyers and sellers of agricultural commodities from unforeseen circumstances. It could be that situation outside control like weather, drought etc. will adversely affect prices of agricultural commodities. By setting up a future contracts at a certain price the buyers and the sellers of such commodities will be protected from unpredictable events.
Others futures contracts are also made on energy, metal, stock index, interest rate and so on.
How to read futures contract specifications?
Contract specifications can be described as the different characteristics that every futures contract is made of. All futures contracts will have the following details:
Trading screen name, Trading symbol, minimum contract size, minimum units for trading and multiples of trading units, currency that the asset is traded in, trading price, settlement price, minimum price fluctuation, expiration date for existing contract, contract series and business days.
Some futures asset can have some specifications that are only unique to it.
What are the differences between Futures and Options?
Lots of people get confused between futures and options. In fact the majority of the assets can be traded either as futures or as options. To understand completely what are the difference between the two it is useful to look at the definition of each of those.
Options – An option contract basically gives the option holder the opportunity but not the obligation to buy or sell an underlying asset for a certain period of time. So the holder of the option can decide to allow the option to expire if this is the decision and no delivery of product is involved in this case.
Futures – When you have a future contract you have the right and the obligation to buy a specified asset. It also give the seller and the buyer the obligation to sell and deliver the asset at a fixed date in the future. This is true unless the holder’s position is terminated before the date set in the future contract.
What is the difference when trading an asset as future or as an options asset?
There are a number of differences that we have summarised below:
Obligation – an option holder has no obligation to exercise the option by the expire date. In the futures there are obligations to both the buyer and the seller in a futures contract to respect the agreement made in the futures contract.
Delivery – The delivery of the asset is compulsory when doing a futures contract but it is not like this in an options contract.
Premiums – options trades do require a payment of a premium or from the dealer to the trader or from the trader to the dealer. In future contracts there are no payment of premiums involved.
Contract sizes – normally contract sizes are much larger for futures trades than for options. This is the reason why executing futures trades requires much larger margin than executing options trades.
Profits – Futures traders can make a profit from the difference between the entry price and the expire price of the asset. Options traders do not normally need to profit from the difference in price: option sellers make a margin only from the premiums they do receive.
What are the differences between CFDs and Futures?
Many don’t have too clear the difference between CFDs (Contract for Difference) and Future. The reason is that probably several assets can be traded both as CFDs and futures. A trader however would need to know what are the differences between the two and we have tried to highlight some below so that everything is much clearer:
Delivery – when you dealing with CFD you are not required the physical delivery of the asset that you are trading. CFDs also have much bigger liquidity compared with Futures contracts. The reason is that CFD trades are done with the brokers as the market makers and this ensure that there is always a counterparty for any of those deals. In futures trades there is a commission structure and for high volume traders it makes it cheaper to trade assets this way. Depending on the volume and trader the futures contracts can be bespoke and this makes the entry barriers quite high which effectively cut off smaller retail traders. For traders with small capital CFDs are much more accessible in terms of capital and margin requirements.