Finance

by James J. Dehoiver

A futures contract is a legally binding agreement between a buyer and a seller that calls for the seller to deliver to the buyer a specified quantity (and quality, for commodities) of a specific asset at a future date for a price agreed today.

To make money trading futures you need to be a buyer of the contract if you think the value of the commodity is going to go up, and a seller of the contract if you think it will go down. The settlement takes place at a future date but you always have to buy and sell at todays prices.

Futures contracts are regulated by a number of large exchanges such as the the CBOT and the LIFFE. When you either buy or sell a contract most traders do not hold it until the settlement date, but usually will close the contract for a profit when the market moves in their favor.

The futures market was originally started to help people like farmers and merchants manage the risk of their products against the potential supply and demand of the market. In farming for example when there is a bumper crop of say corn the price can fall dramatically and hurt the farmer, but if they have already sold a contract at a certain price they can still get a fair price for their products.

The coffee merchant also experiences the same turbulence in prices due to fluctuating supply and demand. The only difference is that a good price for the farmer is bad for the merchant and vice versa. If neither the farmer nor the merchant knows what the price of beans will be at harvest time, it is difficult for them as they do not know how much money they can spend now in anticipation of future profits.

Normally the farmer and the merchant will form a contract early in the season long before harvest time for the price of the crop, this is in effect a futures contract. Both the farmer and the merchant are able to reduce their trading risks in this way.

Futures markets have evolved to include markets whose underlying asset is a financial asset, such as a bond or a portfolio of stocks. Most of the contracts traded can be classified as either commodity futures or financial futures, depending on whether the underlying asset is a commodity or a financial asset.

The CBOT was started in 1848 for the benefit of the farmers and merchants. The exchange was to regulate both the quality and quantity of the actual crop that was being traded. Today the CBOT offers many contracts on items like wheat, silver, corn, bonds and soybeans.

The CME was started in 1919, it’s main purpose was to enable a futures market in such items as pork bellies and live cattle. Today it also regulates the S&P500 stock index which is a very popular index for traders, including day traders.

Another large futures exchange is the London International Futures and Options Exchange (LIFFE) which started in 1982. It has grown very fast since then and financial products like the FTSE100, the GILT and Short Sterling trade on that exchange.

In Germany the EUREX is a big exchange and is 100% electronic, it started out as the DTB in 1990 before electronic systems became popular, at the time open outcry pits systems were still in use by many exchanges.

One of the biggest futures markets in the world was the German Bund, which, during the first half of the 90’s, was the biggest contract traded on LIFFE. The Bund pit on the floor of LIFFE was the biggest and the most active, it was the heart of the trading floor. The Bund was also traded on the DTB, but in much smaller quantities.

Many markets in futures have very high volumes and hence very good liquidity, these are attractive markets for traders. The high leverage means that profits can be made very fast when the market moves, however money can also be lost very fast. If you are even thinking of trading futures make sure that you learn as much as you can before using real money.

About the Author:

James J. Dehoiver is an expert futures trader and will teach you how to day trade futures as well as some delta neutral futures strategies, checkout his site now.