The date set in the futures contract is called the expiry date and trade in ticks. Ticks are the smallest price increment for a trade and are generally one cent. The exception is S&P 500 futures, which have ticks equal to a quarter on an index point. Futures that trade on an exchange generally have a standardized contract, set by the exchange, and have no counterparty risk because the exchange clears all trades.
Why Trade Futures?
Business owners generally use futures contracts to hedge risk. For example, a corn farmer can use a futures contract to lock in a certain price for their corn months ahead of time. An airline can use futures to hedge against the risk of rising fuel prices. Traders can use futures contracts to speculate. Individuals can trade futures using a brokerage account such as Schwab or TDAmeritrade. Futures trading is known for its leverage. Where equity trading typically requires 50% equity, futures trading can be done with as little as 3%. That means for every $1,000 in the trade, you only need to put $30 down. This level of leverage makes trading futures one of the riskiest investments.
Example of Futures
Let’s say a soybean farmer is worried that soybean prices will collapse prior to harvest and wants to lock in a price for part of the potential harvest now. The farmer can use a brokerage account or even the CME Group website to look through current quotes for different futures contracts (they are designated by date, so futures due in November would be called NOV Soybean Futures). If the farmer finds a price that guarantees sufficient profit, they can sell the contract and deliver the soybeans at the contract date.
Types of Futures
Futures can be based on a wide variety of underlying assets. Here are some different types of futures contracts:
Financial futures: Financial futures include stock indexes, commodity indexes, and U.S. Treasury debt instruments.
Currency futures: There are several currencies available for trading via futures contracts, including everything from the U.S. dollar and the Brazilian real to cryptocurrencies such as bitcoin and ethereum.Energy futures: Energy futures include crude oil, natural gas, and other petroleum products such as gasoline and heating oil as well as ethanol.Agricultural futures: These include grain, livestock, and food and fiber futures such as wheat, cattle, and coffee respectively.Metal futures: Precious metals such as gold and silver, and industrial metals like copper can be traded.
Futures Costs and Trading Requirements
Futures trading costs are commissions to the broker. For example, Charles Schwab charges $2.25 per trade. Exchange and regulatory fees are also charged. Exchange fees vary by product, and regulatory fees are two cents per contract.
Futures vs. Options
Options and futures are both derivatives; the difference is obligation. Futures contract agreements obligate the seller to deliver on the contracts’ dates. Options contracts give the buyer the right, but not the obligation, to either buy or sell the contract by the maturity date.
Alternatives to Futures
Investors who want to speculate on commodities but don’t want to use margin or set up a special account to trade futures can use exchange-traded funds (ETFs) or exchange-traded notes (ETNs) to invest in commodities.
