Stock market futures are contracts where a buyer or seller must transact at a predetermined date and price.
What are futures?
Futures are contracts where a buyer and seller are obligated to transact on a predetermined date and price. The future date is also known as the expiration date.
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You can buy or sell different types of assets, including stocks, securities, and commodities.
The following are common U.S. Indices that are used for futures trading:
- E-mini S&P 500 (ES).
- E-mini Dow (YM).
- E-mini Russell 2000 Index (RTY).
- E-mini Nasdaq-100 (NQ).
You can also trade energy and metals, such as crude oil, heating oil, gold, silver, copper, and platinum.
In the futures contract, you’ll specify whether you’re taking a long or short position. A long position means that you’re the buyer, and a short position means you’re the seller.
One of the main benefits of futures contracts is that you can lock in a fixed price, which reduces risk and uncertainty.
Since prices are constantly fluctuating, the ability to buy or sell on a future date and at a specific price reduces the risk of loss.
Aside from navigating risk and uncertainty, futures allow you to speculate the price movement of an asset. This can result in big gains or losses.
Common futures markets
A futures exchange or market is where futures contracts can be purchased or sold. The following are common futures markets:
- CME Group (CME), the world’s largest financial derivatives exchange.
- ICE Futures US (ICEUS).
- Chicago Board of Trade (CBOT).
- New York Mercantile Exchange (NYMEX), a commodity futures exchange owned by CME Group.
- COMEX, an exchange for trading metals. It’s also owned by CME Group.
How it works
As an individual trader, you must open an account with a registered broker to have access to the futures exchange. Platforms such as Interactive Brokers, Charles Schwab, E-Trade, TD Ameritrade, and TradeStation offer futures trading.
To invest in futures, you need to be able to satisfy an initial margin requirement. It’s a small deposit that’s required to enter into a futures contract.
The initial margin requirement is set by the futures exchange. It’s between 3% and 12% of the notional value, which is the total value of the contract.
The small deposit controls large assets, which means that small changes result in big gains or losses.
If the losses are substantial, you must add more money. This is also known as a margin call. It’s when a brokerage firm demands a customer to bring margin deposits up to the initial or original margin levels to keep the position.
The leverage is what makes futures contracts attractive.
The expiration date results in one of two ways. It can be settled financially or physically.
If you’re investing in stock market futures, you’ll get cash when the contract expires. If you’ve invested in physically settled commodities, such as gold, that’s what you’ll receive at expiration.
Closing a position
There are two ways to close your position. The first way is to purchase the opposite futures contract for the same strike price, expiration date, and assets. If you’d like to close a long position, take a short position, and vice versa.
The second method is to sell the contract to someone else. Instead of ending the contract, this will end your position. The contract’s expiration date, price, and assets will remain the same.
It can be a risky investment because you can end up with debt. When you invest in stocks, you can lose the money that you’ve invested if a stock plunges. However, you’ll never lose more than the amount that you initially invested.
With futures contracts, it’s possible to lose more than your initial investment or initial margin requirement.
Futures are regulated by the Commodity Futures Trading Commission (CFTC). It’s an independent agency of the US government that was established in 1974.
They’re in charge of promoting the integrity, resilience, and vibrancy of the U.S. derivatives markets. It includes futures, options, swaps, and other derivatives.
Frequently asked questions
What are the different types of futures contracts?
The different types of futures contracts are stock futures, index futures, currency futures, commodity futures, and interest rate futures.
How do I know how much I’ve gained or loss?
Futures are settled on the expiration date. However, they’re also settled daily. It’s known as market-to-market and determines the profit or loss after the trading day.
Who are futures contracts for?
Speculators and hedgers use futures contracts. Speculators bet on the future price of an asset or security. Hedgers use it to lock in a price for commodities or goods.
Futures contracts are popular because they’re commonly used to hedge against price volatility. They give buyers and sellers the right to transact on an asset at a specified future price and date.
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About David Em
David Em is the founder of More Money More Choices, which he launched to help you take control of your finances and build your dream life. Before More Money More Choices, David worked in leadership positions in the finance industry.