How do futures contracts work

In December, the end date of the contract is approaching, which is on the third Friday of the month. Futures contracts are an investment vehicle that allows the buyer to bet on the future price of a commodity or other security. There are many types of futures contracts available, on assets such as oil, stock market indices, currencies, and agricultural products.

Unlike forward contracts, which are customized between the parties involved, futures contracts trade on organized exchanges such as those operated by the CME Group Inc.

Futures contracts are popular among traders, who aim to profit on price swings, as well as commercial customers who wish to hedge their risks. Yes, futures contracts are a type of derivative product. They are derivatives because their value is based on the value of an underlying asset, such as oil in the case of crude oil futures. Like many derivatives, futures are a leveraged financial instrument, offering the potential for outsize gains or losses. As such, they are generally considered to be an advanced trading instrument and are mostly traded only by experienced investors and institutions.

Oftentimes, traders who hold futures contracts until expiration will settle their position in cash. In other words, the trader will simply pay or receive a cash settlement depending on whether the underlying asset increased or decreased during the investment holding period. In some cases, however, futures contracts will require physical delivery.

In this scenario, the investor holding the contract upon expiration would be responsible for storing the goods and would need to cover costs for material handling, physical storage, and insurance. CME Group. American Style Options. Commodity Futures Trading Commission. Trading Instruments. Actively scan device characteristics for identification.

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Overview of Futures Products. How to Trade Futures. Futures Trading Considerations. Table of Contents Expand. What Are Futures? Understanding Futures. Using Futures. Real-World Example of Futures. Key Takeaways Futures are derivative financial contracts obligating the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and set price. These types of traders can buy and sell the futures contract, with no intention of taking delivery of the underlying commodity; they're just in the market to wager on price movements.

With speculators, investors, hedgers and others buying and selling daily, there is a lively and relatively liquid market for these contracts. Commodities represent a big part of the futures-trading world, but it's not all about hogs, corn and soybeans. Stock futures investing lets you trade futures of individual companies and shares of ETFs. Futures contracts also exist for bonds and even bitcoin.

Some traders like trading futures because they can take a substantial position the amount invested while putting up a relatively small amount of cash.

That gives them greater potential for leverage than just owning the securities directly. Most investors think about buying an asset anticipating that its price will go up in the future. But short-selling lets investors do the opposite — borrow money to bet an asset's price will fall so they can buy later at a lower price. One common application for futures relates to the U.

If stocks fall, he makes money on the short, balancing out his exposure to the index. Conversely, the same investor may feel confident in the future and buy a long contract — gaining a lot of upside if stocks move higher.

Learn how to day trade. Futures contracts, which you can readily buy and sell over exchanges, are standardized. Each futures contract will typically specify all the different contract parameters:. How the trade will be settled — either with physical delivery of a given quantity of goods, or with a cash settlement.

The quantity of goods to be delivered or covered under the contract. The currency unit in which the contract is denominated. The currency in which the futures contract is quoted. Grade or quality considerations, when appropriate. For example, this could be a certain octane of gasoline or a certain purity of metal.

If you plan to begin trading futures, be careful because you don't want to have to take physical delivery. Most casual traders don't want to be obligated to sign for receipt of a trainload of swine when the contract expires and then figure out what to do with it.

But borrowing money also increases risk: If markets move against you, and do so more dramatically than you expect, you could lose more than you invested. Leverage and margin rules are a lot more liberal in the futures and commodities world than they are for the securities trading world. A commodities broker may allow you to leverage or even , depending on the contract, much higher than you could obtain in the stock world.

The exchange sets the rules. If so, you may be interested in the futures markets as a capital-efficient way to gain exposure to six different asset classes, virtually around the clock. Get an overview of how futures contracts work, from specs to symbols, and learn how margin and leverage affect capital.

Want to start trading futures? Apply now. Download now. Futures investing basics. Educational videos.