What to know about futures contracts — and the 5 reasons investors trade them Show
Insider's experts choose the best products and services to help make smart decisions with your money (here’s how). In some cases, we receive a commission from our our partners, however, our opinions are our own. Terms apply to offers listed on this page.
LoadingSomething is loading. Thanks for signing up! Access your favorite topics in a personalized feed while you're on the go. Much of investing is based on how an investor feels about the economic landscape and the ways in which that investor can profit or protect themselves. If you believe in a company's ability to succeed, perhaps you might buy the stock or a call option. 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. But what exactly are futures, how do they work, and what sets them apart from options?
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. Futures contracts can be critical for businesses that depend on certain input goods to operate. The airline industry is well-known for this, because of the fluctuating prices for jet fuel, and uses futures contracts to lock in prices and protect against unexpected costs. While futures contracts based on commodities like corn, oil, and wheat are the most common, there are several other asset types that a futures contract can derive its value from. Here's a short list:
Understanding how futures workThere are five key parts to every futures contract, also known as standard contract specifications.
Futures contracts can be purchased on margin, meaning that an investor only needs to put in a small amount of money to control a much larger sum in the market. The minimum amount of money required to enter into a futures contract is known as the initial margin requirement. These requirements are set by the futures exchange and are subject to change. Generally, the margin requirement for futures contracts is between 3% to 12%. This means, depending on the price of the contract, an investor could spend $5,000 of their own cash to control a $100,000 investment, which represents only 5%. This amount of leverage can present serious risks if the investment does not go as planned and in some cases could cause an investor to lose more than the initial amount invested. Pros and cons of futuresAs with any investment vehicle, there are pros and cons that you should be aware of. These are some of the major advantages and disadvantages. Futures vs. optionsFutures and stock options have many similarities — both are contracts between two parties and can allow an investor to hedge and protect their portfolio — but there are some key differences that you should be aware of. The bottom lineInvesting with futures can be a way to diversify your portfolio in ways that the more traditional stock and bond investor can't. This additional exposure comes with a few trade-offs, which include higher rates of volatility, longer trading hours, and special tax advantages. "Futures tend to be a more complex or advanced financial instrument," adds Henderson. While the potential for large profits may be tempting, carefully consider the risks before entering into futures trading. It may also be wise to consult a CFP® professional to ensure that a negative move in the futures market does not threaten your overall financial security.
Kevin L. Matthews II is a No. 1 bestselling author and former financial advisor. He has helped hundreds of individuals plan for their retirement in addition to managing more than $140 million in assets during his advisory career. In 2017, he was named one of the Top 100 Most Influential Financial Advisors by Investopedia. Kevin holds a bachelor's degree in Economics from Hampton University and a certificate in financial planning from Northwestern University. In 2020, he graduated from the University of Texas at Austin with a Master's in Technology Commercialization (MSTC). Read more Read less Related articlesMore... Which of the following is a contract that defines the terms of future contracts between parties such as payment terms?Definition: A futures contract is a contract between two parties where both parties agree to buy and sell a particular asset of specific quantity and at a predetermined price, at a specified date in future. Description: The payment and delivery of the asset is made on the future date termed as delivery date.
What is a futures contract called?Futures are a type of derivative contract agreement to buy or sell a specific commodity asset or security at a set future date for a set price. Futures contracts, or simply "futures," are traded on futures exchanges like the CME Group and require a brokerage account that's approved to trade futures.
What is an example of a futures contract?Futures Trading Example:
For example, if someone wants to buy a September crude oil futures contract. So they make a futures contract that they will buy 200 barrels of oil from the agreed price as of September expiration whatever the market price at that time.
What are the different types of futures contracts?The different types of futures contracts include equity futures, index futures, commodity futures, currency futures, interest rate futures, VIX futures, etc. The concept across all the types of futures is the same.
|