What Are Futures?
A sort of derivative contract arrangement known as a futures stipulates the purchase or sale of a certain commodity asset or security at a predetermined price at a future date. Futures contracts, sometimes known as “futures,” are exchanged on exchanges that deal in futures, such as the CME Group. In order to trade futures, a brokerage account must be approved.
Like an options deal, a futures contract has a buyer and a seller. When a futures contract expires, both the buyer and the seller of the futures contract are required to purchase and receive the underlying asset, in contrast to options, which may lose all of their value at that point.
Uses For Futures
In investment, futures are often used for two purposes: speculation and hedging (risk management).
Hedging with futures
Institutional investors and businesses generally utilize futures contracts—which are bought or sold with the aim of receiving or delivering the underlying commodity—for hedging, frequently to assist control the future price risk of that commodity on their operations or investment portfolio.
Speculating with futures
Futures contracts can be purchased and traded up until the point of expiration and are often liquid. For traders and speculative investors who neither own nor desire to possess the underlying commodity, this is a crucial aspect. In order to voice their view on the direction of the commodities market and maybe benefit from it, they can purchase or sell futures. Then, in order to release themselves from any commitment regarding the real commodity, they will purchase or sell an offset futures contract position prior to expiration.
Why Engage In Futures Trading?
Futures are primarily used by traders and individual investors to bet on how the price of the underlying asset will fluctuate in the future. By voicing their predictions about potential market trends for a particular commodity, index, or financial instrument, they aim to make money. Additionally, some investors utilize futures as a hedge, usually to assist balance any negative effects on their portfolio or business from future market movements in a specific commodity.
Naturally, one may speculate on or protect against potential market movements using equities or exchange-traded funds (ETFs). There are some clear advantages that the futures market may provide that the equity market cannot, but they all include hazards that you should be aware of.
Leverage: In a margin account, you must pay at least 50% of the account’s total value in order to establish an equity position. The initial margin requirement for futures is usually set between 3 and 10% of the underlying contract value. You run the danger of losing more money than you initially invested when using leverage, but it also increases your possibility for higher returns in relation to your investment.
Diversification: In a manner that stocks and ETFs cannot, futures provide some additional opportunities to diversify your investments. As opposed to secondary market goods like equities, they might provide you with direct market exposure to underlying commodities assets. They also provide you access to particular assets that aren’t often available in other marketplaces. If you’re searching for methods to assist control some risk associated with impending events that might influence the markets, you can also consider using futures.
Short Selling: Because the margin requirement for long and short positions in futures is the same, it is possible to take a bearish posture or reverse a trade without incurring additional margin obligations.
Tax Benefits: When compared to other short-term trading marketplaces, futures may offer a tax advantage. This is due to the fact that winning futures trading have a 60/40 tax structure, meaning that 40% of earnings are taxed as regular income and 60% as long-term capital gains. In contrast, earnings from stock trading that are kept for less than a year are subject to 100% regular income tax.
Types Of Futures
There are many different financial and commodity-based futures that may be traded, ranging from debt, indices, and currencies to energy, metals, and agricultural items. Among the numerous futures contract examples are:
Financial Futures
Financial futures come in two varieties: index contracts and interest rate (debt) contracts. While interest rate contracts are used to gain exposure to the interest rate of a particular financial instrument, index contracts offer exposure to certain market index values.
Currency Futures
Exposure to the exchange rate of a real currency or cryptocurrency is possible using currency contracts.
Energy Futures
Energy contracts offer exposure to the cost of popular energy products utilized by governments, businesses, and individuals for consumption as well as for manufacturing, production, and/or transportation.
Metal Futures
Exposure to the price of certain metals, such as steel for homes or gold for computers, which are used by numerous businesses as building and manufacturing materials, is possible through metal contracts.
Grain Futures
Grain futures offer exposure to the prices of processed soybeans and raw grain materials used for animal feed as well as commercial processing into other products (such corn syrup and ethanol).
Livestock Futures
Contracts for livestock expose parties to the costs of live animals used in the production, distribution, and processing of meat products.
Food & Fiber Futures
These contracts offer exposure to the prices of dairy products as well as some agricultural items that are cultivated rather than harvested or mined (often referred to as “Softs”).
