Futures

Futures, also known as futures contracts, are an integral part of the financial market. They enable individuals and institutions to trade a specific asset or commodity at a predetermined date and price in the future. These contracts are legally binding agreements between two parties, and they also track the price movement of the underlying asset or commodity.

Futures belong to the category of derivative financial instruments. This means that their value is derived from another asset. The underlying asset can be anything from commodities like oil, gold, or wheat to financial instruments like stocks, indices, or even cryptocurrencies like Bitcoin.

Investors utilize futures for various reasons. For example, they can be used as a risk management tool to hedge against price fluctuations. A farmer, for instance, might use futures to protect themselves against a drop in the price of wheat by selling wheat futures. On the other side, a manufacturer might buy those same futures to ensure a stable supply and price of wheat for their production needs.

Additionally, futures are widely used for speculative trading. Traders aim to profit from the price movements of the underlying assets without actually owning them. Speculators buy or sell futures contracts with the expectation that the price of the underlying asset will move in their favor, allowing them to sell the contracts at a higher price or buy them back at a lower price.

When it comes to futures trading, it is important to understand the concept of expiration dates. Each futures contract has a specific expiration date, which represents the date on which the contract expires. The expiration date is associated with a particular month and year, allowing for a clear description. For example, December Bitcoin futures refer to BTC futures contracts that expire in December.

One of the key features of futures trading is leverage. Leverage allows traders to control a larger position in the market with a smaller amount of capital. Futures trading platforms offer leverage options, meaning that traders only need to invest a percentage of the total contract value, while the remaining amount is borrowed or leveraged from the platform. The initial required amount is known as the margin.

The margin requirement is determined based on the trader’s creditworthiness and the conditions set by the trading platform for leveraged trading. Leverage can amplify both profits and losses, so it should be used with caution. Traders need to carefully manage their risk and be aware of the potential for significant losses if the market moves against them.

When a futures contract reaches its maturity or expiration date, it can be settled in two ways: physically or through cash settlement. Physically settled futures involve the exchange of the underlying asset upon expiry. For example, if you hold a physically settled oil futures contract, you would receive the physical barrels of oil upon expiration.

On the other hand, cash-settled futures contracts describe a situation where the underlying asset is converted into cash upon maturity. Let’s say you hold a cash-settled S&P 500 futures contract, and the contract expires. In this case, the settlement would be in cash based on the final value of the S&P 500 index.

In the futures market, traders often refer to the term “tick.” A tick represents the smallest price movement of a futures contract within a 24-hour period. It is important to note that a tick can indicate either an increase or decrease in price. For example, if the price of a futures contract moves from $100 to $101, it would be considered a one tick increase.

The tick size may vary depending on the specific futures contract and the market it trades in. Traders need to understand the tick size as it impacts the potential profit or loss of a trade.

In summary, futures contracts allow individuals and institutions to trade specific assets or commodities at a predetermined date and price in the future. They serve various purposes, including risk management and speculation. Understanding expiration dates, leverage, and settlement methods is crucial for successful futures trading. Additionally, being aware of the tick size and its impact on potential profits or losses is essential for making informed trading decisions.