What are futures?
This can be anything from a stock market index such as the S & P 500 or FTSE 100 to commodities such as wheat, oil, gas or gold. Futures trading actually has two specific purposes.
First, they can be used as a speculative tool to profit from the future value of a financial instrument. This works similarly to any other investment product in the financial markets. Alternatively, futures can be used by large producers, farmers or traders to fix the price of the asset in which they have a stake.
Here is good example from thai traders and its traslation: "ตัวอย่างเช่นหากราคาน้ํามันใน ฟอเร็กซ์ exness ประเทศไทย 2022 อยู่ในระดับต่ําสุดเป็นประวัติการณ์สายการบินอาจตัดสินใจซื้อสัญญาซื้อขายล่วงหน้าเพื่อป้องกันความเสี่ยงจากการเพิ่มขึ้นอย่างฉับพลัน. ในแง่ของรายละเอียดสัญญาซื้อขายล่วงหน้ามีวันหมดอายุเสมอ - โดยเฉลี่ยสามเดือน."
"For example, if the price of oil is currently at record lows, an airline might decide to buy futures contracts to hedge against a sudden increase. In terms of detail, futures contracts always have an expiry date - on average three months."
Your gains and losses are determined by the market price of the asset when the futures contract expires. In other words, you would have to multiply the difference between the purchase price and the strike price by the number of contracts you hold. In other cases, you may choose to trade your futures contract before expiry, selling based on the current market value of the asset.
Understanding Futures Trading - The Basics
Futures trading can be a complex battleground for novices. Therefore, it is important that we break down the basics in more detail. Before we do, let's look at a very simple example to clear the fog.
Futures trading example
Let's say you believe that oil is severely undervalued at USD 20 per barrel. You believe that the price will rise by over USD 30 in the coming weeks or months. As a result, you decide to buy some futures contracts.
- The futures contract has a maturity of three months
- The current expiration price for each contract is 27 USD
- You decide to buy 100 contracts
- When the futures contracts expire in three months, the oil price is 40 USD per barrel
- This is $13 per barrel higher than the contract price of $27, so you have made a profit
- In total you have 100 contracts, so you make a total of $1,300 on this particular futures trade (100 x $13).
As you can see above, our profit was based on the difference between the contract price ($27) and the actual market price when the contracts expired ($40). If the trade had gone the other way - meaning the price ended 13 USD lower, we would have made a loss of 1,300 USD (100 x - 13 USD).
It is important to note that there will always be a difference between the price of the futures contract and the current market price. For example, in the section above we noted that the "current" oil price was USD 20, but the 3-month futures contract was USD 27.
This is crucially because the markets will use a number of variables and conditions to determine what the future price of the asset is likely to be.
It is also important to note that the price of a 3-month futures contract is different from that of a shorter or longer contract. Using the same example for crude oil, a 1-month contract may have an expiry price of $22, while a 12-month contract may be much higher at $45.
Long or short
Once you have determined the expiry price of the futures contract, you need to decide which way you think the markets will go. This must be either a long or a short order. With some brokers this is called a buy or sell order.
So if you think the price of the asset will be higher than the futures contract, you will have a long order. If you think the asset will go lower, you will be short. This is one of the biggest advantages of futures trading, as with traditional assets you can only speculate on the rising price.
In traditional futures, the majority of contracts have a maturity of 3 months. In terms of the specific date, this is usually the last Friday of the month in question. With this in mind, it is also possible to enter into a shorter or longer contract - thanks to the financial institution that creates the market.