Introduction to Futures

Every futures contract has an underlying asset, the quantity of the asset, delivery location, and delivery date. For example, if the underlying asset is light sweet crude oil, the quantity is 1,000 barrels, the delivery location is the Henry Hub in Erath, Louisiana and the delivery date is December 2017.

All futures contracts have a specified date on which they expire. Prior to the expiration date, traders have a number of options to either close out or extend their open positions without holding the trade to expiration, but some traders will choose to hold the contract and go to settlement.

The contract unit is a standardized size unique to each futures contract and can be based on volume, weight, or a financial measurement, depending on the contract and the underlying product or market.

One of the defining features of the futures markets is daily mark-to-market (MTM) prices on all contracts. The final daily settlement price for futures is the same for everyone.MTM was a distinctive difference between futures and forwards until the regulatory reform enacted after the financial crises of 2007-2008. Prior to those reforms most OTC forwards and swaps did not have an official daily settlement price so clients never knew their daily variation except as described by a theoretical pricing model.

Securities margin is the money you borrow as a partial down payment, up to 50% of the purchase price, to buy and own a stock, bond, or ETF. This practice is often referred to as buying on margin.Futures margin is the amount of money that you must deposit and keep on hand with your broker when you open a futures position. It is not a down payment and you do not own the underlying commodity.

Futures contracts have a limited lifespan that will influence the outcome of your trades and exit strategy. The two most important expiration terms are expiration and rollover.

Market participants trade in the futures market to make a profit or hedge against losses. Each market calculates movement of price and size differently, and as such, traders need to be aware of how the market you are trading calculates profit and loss. To determine the profit and loss for each contract, you will need to be aware of the contract size, tick size, current trading price, and what you bought or sold the contract for. WTI Crude Oil futures, for example, represents the expected value of 1,000 barrels of oil. The price of a WTI futures contract is quoted in dollars per barrel. The minimum tick size is $0.01.

Hedgers are primary participants in the futures markets. A hedger is any individual or firm that buys or sells the actual physical commodity. Many hedgers are producers, wholesalers, retailers or manufacturers and they are affected by changes in commodity prices, exchange rates, and interest rates. Changes to any of these variables can impact a firm’s bottom line when they bring goods to the market. To minimize the effects of these changes hedgers will utilize futures contracts. Unlike speculators who assume market risk for profit, hedgers use the futures markets to manage and offset risk.

Speculators are primary participants in the futures market. A speculator is any individual or firm that accepts risk in order to make a profit. Speculators can achieve these profits by buying low and selling high. But in the case of the futures market, they could just as easily sell first and later buy at a lower price.