How is futures traded

Here, the buyer must purchase or the seller must sell the underlying asset at the set price, regardless of the current market price at the expiration date.

Underlying assets include physical commodities or other financial instruments. Futures contracts detail the quantity of the underlying asset and are standardized to facilitate trading on a futures exchange. Futures can be used for hedging or trade speculation. For example, you might hear somebody say they bought oil futures, which means the same thing as an oil futures contract. Futures contracts are also one of the most direct ways to invest in oil.

The term "futures" is more general, and is often used to refer to the whole market, such as, "They're a futures trader. Futures contracts are standardized, unlike forward contracts. Forwards are similar types of agreements that lock in a future price in the present, but forwards are traded over-the-counter OTC and have customizable terms that are arrived at between the counterparties.

Futures contracts, on the other hand, will each have the same terms regardless of who is the counterparty. Futures contracts are used by two categories of market participants: hedgers and speculators. Producers or purchasers of an underlying asset hedge or guarantee the price at which the commodity is sold or purchased, while portfolio managers and traders may also make a bet on the price movements of an underlying asset using futures.

An oil producer needs to sell its oil. They may use futures contracts to do it. This way they can lock in a price they will sell at, and then deliver the oil to the buyer when the futures contract expires.

Similarly, a manufacturing company may need oil for making widgets. Since they like to plan ahead and always have oil coming in each month, they too may use futures contracts. This way they know in advance the price they will pay for oil the futures contract price and they know they will be taking delivery of the oil once the contract expires.

Futures are available on many different types of assets. There are futures contracts on stock exchange indexes , commodities, and currencies. Imagine an oil producer plans to produce one million barrels of oil over the next year. It will be ready for delivery in 12 months. The producer could produce the oil, and then sell it at the current market prices one year from today.

Given the volatility of oil prices, the market price at that time could be very different than the current price. If the oil producer thinks oil will be higher in one year, they may opt not to lock in a price now.

A mathematical model is used to price futures, which takes into account the current spot price , the risk-free rate of return , time to maturity, storage costs, dividends, dividend yields, and convenience yields.

Contracts are standardized. The CFTC is a federal agency created by Congress in to ensure the integrity of futures market pricing, including preventing abusive trading practices, fraud, and regulating brokerage firms engaged in futures trading. Retail traders and portfolio managers are not interested in delivering or receiving the underlying asset. A retail trader has little need to receive 1, barrels of oil, but they may be interested in capturing a profit on the price moves of oil. Futures contracts can be traded purely for profit, as long as the trade is closed before expiration.

Many futures contracts expire on the third Friday of the month, but contracts do vary so check the contract specifications of any and all contracts before trading them. This gives them control of 1, barrels of oil. Rather, the broker only requires an initial margin payment, typically of a few thousand dollars for each contract.

The profit or loss of the position fluctuates in the account as the price of the futures contract moves. If the loss gets too big, the broker will ask the trader to deposit more money to cover the loss. This is called maintenance margin. The final profit or loss of the trade is realized when the trade is closed. A futures contract gets its name from the fact that the buyer and seller of the contract are agreeing to a price today for some asset or security that is to be delivered in the future.

These two types of derivatives contract function in much the same way, but the main difference is that futures are exchange-traded and have standardized contract specifications. These exchanges are highly regulated and provide transparent contract and pricing data.

Futures Market Participants Learn how the major players in the futures market—producers, hedgers, and speculators—buy and sell futures contracts in an attempt to secure optimal prices. Informative articles. Investor's Manual: What Are Futures? Fun with Futures: Basics of Futures Contracts, Futures Trading What futures markets do over the short and long term can tell investors a lot about what's going on in the world how much it will cost to fill your gas tank before your summer road trip, for example.

Quick info guide. Futures Maximizing capital efficiency. This volatility means that speculators need the discipline to avoid overexposing themselves to any undue risk when investing in futures. If such risk seems too much and you're looking for a way to shake up your investment strategy, consider options instead. Read up on everything you need to know about how to trade options.

It's relatively easy to get started trading futures. Open an account with a broker that supports the markets you want to trade. A futures broker will likely ask about your experience with investing, income and net worth.

These questions are designed to determine the amount of risk the broker will allow you to take on, in terms of margin and positions. There's no industry standard for commission and fee structures in futures trading. Every broker provides varying services. Some provide a good deal of research and advice, while others simply give you a quote and a chart.

Some sites will allow you to open up a virtual trading account. This is an invaluable way to check your understanding of the futures markets and how the markets, leverage and commissions interact with your portfolio. Even experienced investors will often use a virtual trading account to test a new strategy. Depending on the broker, they may allow you access to their full range of analytic services in the virtual account.

Consider our best brokers for trading stocks instead. What are futures? How do futures work? Learn More. Promotion None no promotion available at this time. Stock futures investing. What are futures contracts? The unit of measurement.

The risks of futures investing: margin and leverage. How to trade futures. On a similar note Dive even deeper in Investing. Explore Investing.