Here’s a simple futures trading checklist for you to start with:

Definition of Futures-Just what are futures?

A futures contract is a standardized financial contract between two parties obligating the buyer to purchase a specified commodity or financial instrument of standardized quantity (or the seller to sell an asset), at a predetermined future date and price. The price agreed upon today is the called the futures price. The price is determined by supply and demand. Some futures contracts may call for physical delivery of the asset, while others are settled in cash.

Initial margin must be deposited in order to trade futures. This the amount of money a customer must deposit for each futures contract to be traded. Exchanges set minimum margin requirements for futures contracts, while individual brokerage firms may require a higher margin.

Futures Characteristics:

  • Futures contracts are settled daily and assigned a final value price.
  • Based on settlement price, the value positions are “marked-to-the-market” each day after close.
  • Losses are not allowed to accumulate without some response being required.
  • The terms “futures contract” and “futures” refer to essentially the same thing.
  • To minimize credit risk to the exchange, traders must post a margin or a performance bond, typically 5%-15% of the contract’s value.
  • Futures markets are callow a trader to use very high leverage relative to stock markets.

Standardization of Futures

Futures contracts specify:

  1. The currency in which the futures contract is quoted.
  2. The grade or quality of the deliverable.
  3. Pricing point — the location where delivery must be made.
  4. The delivery month.
  5. The last trading date.
  6. The underlying asset.
  7. The type of settlement, either cash settlement or physical settlement.
  8. The amount and units of the underlying asset per contract.

The value of a futures contract is ultimately tied to the underlying product or instrument (e.g., S&P 500 Index, gold, crude oil, U.S. Treasury bonds or notes, soybeans, etc.) via each contract’s specifications. You can either buy (go long) or sell (go short) any futures contract and your risk (or potential profit) is virtually unlimited.

The contracts are traded on a futures exchange. Futures contracts are exchange traded derivatives. Futures contracts are not “direct” securities like stocks, bonds, rights or warrants. One party agrees to buy the underlying asset in the future (thus establishing a long position) and the other party agrees to sell the asset in the future (thus establishing a short position).

Why Buy a Futures Contract?

Hedging – to reduce risk. Example a flour miller might use a futures contract to set a price now for wheat that he knows he will need to purchase in the future, rather than face the chance that prices could be even higher when he buys the wheat.

Speculating – this is when a person tries to make a profit by predicting the direction a market will move and opening a contract related to the underlying asset.

Futures Contract vs. Options Contract – A futures contract gives the holder the obligation to make or take delivery under the terms of the contract, with options the buyer has the right, but not the obligation, to exercise the option.

Future Date is called the delivery date or final settlement date.

Settlement Price is the official price of the futures contract at the end of day’s trading session on the exchange.

The actual delivery ratio of underlying goods specified in futures contracts is not very high. This is a result of the fact that the hedging or speculating benefits of the contracts can be had largely without actually holding the contract until expiry and delivering the good(s). For example, if you were long in a futures contract, you could go short in the same type of contract to offset your position. This serves to exit your position, much like selling a stock in the equity markets would close a trade.

Futures can be used either to hedge or to speculate on the price movement of the underlying asset. For example, a producer of corn could use futures to lock in a certain price and reduce risk (hedge). On the other hand, anybody could speculate on the price movement of corn by going long or short using futures.

How Does Future Trading Work?

If you have bought a futures contract, your trade will show a profit if prices rise. If you have sold, lower prices will produce a profit.

Futures are usually highly leveraged. This means that if the price moves in the direction you want you could make a huge profit in relation to your initial investment. Conversely, if prices move in the opposite direction, you could get wiped out quickly.

Great Futures Brokers.

  1. TradeStation ( www.tradestation.com ) – one of the best online brokers.
  2. Interactive Brokers Group (www.interactivebrokers.com) – best commission rates.
  3. ExpressFutures.com – great services and good prices.
  4. Lind Waldock (www.lind-waldock.com) -excellent service and trading platform.

    5. Be very careful, study hard and practice before using real money to trade futures.

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