Are you interested in futures trading but don't know where to start? This guide is for you. This post will walk you through the basics of futures trading and provide everything you need to get started.
What Are Futures?
A future is a legally binding arrangement to buy or sell an asset at a pre-fixed price at a specific date in the future. The contracts are traded on an exchange, and the buyer and seller are both obligated to adhere to the terms of the agreement.
Investors use futures to hedge against inflation, protect portfolios from market downturns, and speculate on price movements.
Key Aspects of a Futures Contract
Futures contracts are standardized, which means that each contract has a specific underlying asset, expiration date, and contract size. This makes it easy to trade futures contracts and know what you're getting when you enter into a contract.
The asset underlying a futures contract can be anything from commodities like corn or crude oil to financial instruments like bonds or currencies. These assets are known as the underlying asset.
The contract's price is determined by the supply and demand for the underlying asset. For example, if there is high demand for crude oil futures, the price of the contract will increase.
At expiration, the contract is settled in cash, and the buyer or seller receives (or pays) the difference between the settlement price and the price at which they entered into the contract.
Settling a Futures Contract
If the settlement price is higher than the price they bought the contract, the buyer will receive money. If the settlement price is lower than the price they bought the contract, the buyer will pay money.
The opposite is true for the seller. If the settlement price is lower than the price at which they sold the contract, the seller will receive money. If the settlement price is higher than the price at which they sold the contract, the seller will pay money.
For example, if a trader bought a crude oil future at $100 per barrel and the price of crude oil increased to $105, the trader could close out the position by selling the contract at $105. The trader would then realize a profit of $500 for 500 barrels (the difference between the $100 purchase price and the $105 sale price, multiplied by the contract's size of 500 barrels).
If the price of crude oil had decreased to $95, the trader could close out the position by buying a contract at $95. The trader would then realize a loss of $500.
The key advantage of trading futures is that they provide leverage, allowing investors to control large positions with a small amount of capital. This leverage can lead to both profits and losses, so you need to understand how futures work before trading them. Contact a company like E-Futures if you want to learn more.
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