What you need to know about futures contracts

Futures contract or just futures is an agreement between two parties to buy or sell assets at a predetermined price at a specified date in the future. Underlying asset can be stock market index, currencies or most common commodities - oil. gasoline and gold. Buyer of the future has the obligation to buy the underlying asset when the future contract expires just like the seller has the obligation to provide the asset at the expiration date. Futures that are traded on commodity future exchanges are more standardized and regulated like Chicago Mercantile Exchange or New York Mercantile Exchange. Standardized contract means that for instance, one future oil contract is for 1,000 of oil and one gold contract is for 100 troy ounces of gold. The Commodities Futures Trading Commission regulates the exchanges and require buyers and sellers to be registered.

Futures are used by two types of market participants - hedgers and speculators. Guarantees to buy or sell at a certain price reduces risk. If the price of an commodity, the buyer makes money as he gets commodity at a lover price and vice versa if the price goes down seller makes money because he is selling the commodity at a higher predetermined price. Prices of commodities are volatile and changes often so the contract prices change as well which makes them risky investment. Price of the future is calculated through mathematical model which takes into account multiple factors like storage costs and time of maturity.

Futures can be traded only for profit as long as the trade is executed before expiration date. This is done by retail traders and portfolio managers that are not interested in the underlying asset but make profit on the price fluctuation of commodities and therefore the future contract. Trading futures requires broker and he or she will only require initial margin payment for the contract. If the price fluctuates a lot broker may reacquire from trader to deposit more money to recover the loss. Every time when transaction occurs the price of the contract moves. The minimum price fluctuation that future can make is called tick. Tick movement represents monetary gain or loss. Final profit or loss is realized when the trade is closed.

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