This may sound like a ridiculously simple subject to write about, but I suspect you would be shocked by how many traders, if pressed, could not come up with a plausible answer when asked to define a futures contract. For the purpose of this article I am going to confine our discussion to financial futures contracts, though there are futures contracts that can be purchased on a wide range of commodities.
Let’s start by saying that a financial futures contract is a derivative, or an agreement to buy or sell something in the future. Let’s contrast that definition to a stock, which represents direct ownership, or equity, in a company or other legal entity. If you buy a futures contract, you are basically agreeing to buy something that a seller has not yet produced for a set price. Let’s be clear here, though, because you purchase a futures contract does not necessarily mean you have any plans for taking delivery of the underlying security for which you purchased the futures contract. It is normal for buyers and sellers in the futures market primarily enter into futures contracts to hedge risk or speculate rather than to exchange physical goods.
We will ignore the hedging aspect of futures contract because that would be a rather lengthy article in and of itself. No, as traders we are buying and selling futures contracts as a means of speculation and hopefully profit from the speculation. In every futures contract, everything is specified: the quantity and quality of the commodity, the specific price per unit, and the date and method of delivery. The “price” of a futures contract is represented by the current price of the underlying commodity or financial instrument that will be delivered in the future.
The daily price of financial futures contracts (and all futures contracts, for that matter) change throughout the course of the day in a manner very similar to price movement on the stock market. In the case of financial futures contract, there are four months that financial futures contracts mature (the year is split into four equal quarters, or three months) and traders buy and sell financial futures contracts based upon what they feel the price of the underlying security will be on the month the financial futures contract expires.
Most of my articles are written about the ES Emini futures contract. I should point out, at this juncture, that an emini futures contract is one fifth the value of a full sized contract. The ES is a mini sized version of the larger S&P 500 contract.
Why would the exchanges create emini contracts?
The answer is simpler than you might think…they developed the mini contracts so that individual investors can participate in the futures market. The emini essentially allowed futures contracts to be traded by individuals where before they were primarily traded by wealthy individual traders and institutional traders. The emini opened up an entire area of investing to the small investor and these markets have been growing at an unprecedented rate since their inception. The ES emini contract now trades more than a million contracts a day. I think at this point I should also point out that futures trading is based upon leverage.
What the heck is leverage?
When you buy a stock you are expected to pay the entire stock price within three days of purchase. For example, if you purchased 100 shares of stock a for $10/share, your stockbroker would expect payment of $1000 with three days of you order. This is not so with futures contracts where you typically Online Casino Deposits money to cover margin requirements. The margin on a ES emini contract ranges from $500-1000 and you are actually controlling 5 times the value of the futures price.
Before we get to far into the specifics, lets close with a basic understanding of a futures contract. It is an agreement between two parties (facilitated by the exchange) to deliver an equity of pre-determined value at a certain time. Futures trade very similar to traditional equities and have a high degree of liquidity.
I plan to continue with some of these futures basics in the coming days, so look for articles of a similar vein to help clarify some of the questions you may have about the nature of futures contracts.
