Futures are exchange-based contracts that allow two parties to agree on buying or selling a specific asset at a predetermined price on a set future date. These contracts are a type of derivative, meaning their value comes from an underlying asset. Common underlying assets include:
Futures are traded on regulated exchanges. As for futures markets, they operate almost 24 hours a day, five days a week.
The underlying assets for futures contracts are diverse. Hard commodities such as precious metals and natural gas are frequently traded. Soft commodities are also common. Some examples include:
Watch this video to know more about futures:
Aside from futures, there are other types of derivatives that your clients might want to look at when building their portfolios.
Futures trading takes place on regulated exchanges. These exchanges provide a platform for buyers and sellers to meet and trade contracts. Each trade creates a new contract, and there is no limit to how many contracts can be created. This is different from stocks, where the number of shares is fixed.
The price of a futures contract is determined by supply and demand, as well as the expectations of traders. There are also different pricing models.
For instance, the Cost of Carry Model says that the futures price equals the spot price plus the cost of holding the asset until the contract expires. The Expectancy Model looks at what traders think the spot price will be at the contract’s expiration date.
Futures contracts can be traded in several ways. The most common is through a regulated exchange, which requires a broker and follows strict rules to reduce the risk of default. There is also over-the-counter (OTC) trading, where the terms are set by the two parties involved. However, OTC contracts are less liquid and carry more risk.
Another way to trade is through contracts for difference (CFDs). With CFDs, your clients do not own the asset. Instead, they agree to exchange the difference in price from when the position is opened to when it is closed. CFDs are popular because they allow for leveraged trading and are available through many online brokers.
Check out this video on futures trading:
Do you have clients who want to start trading stocks, futures, or other assets? Feel free to check out our beginner’s guide!
Every futures contract comes with a set expiration date. This is the date when the contract must be settled, either by delivering the underlying asset or by closing out the position. The length of time a futures contract lasts depends on the specific contract and the asset involved.
Most futures traders are not looking years into the future. They are focused on price prospects over the next few months. As new information about supply and demand comes in, the price of the futures contract changes. Traders take positions based on what they think the price will be when the contract expires.
When the expiration date arrives, trading for that certain contract stops, and a final settlement price is determined. Many investors will have already decided what to do with their position before this date.
Some will close out the contract to avoid taking delivery of the asset, while others might roll their position into a new contract with a later expiration date.
The standardized nature of futures contracts also means that the terms—such as quantity, quality, and delivery—are set in advance. The only thing that changes is the price. This standardization helps create a transparent and efficient market where buyers and sellers can meet.
Check out these advantages in trading futures contracts:
Here are some pitfalls in trading futures contracts:
Futures contracts are not the same as stocks. When your clients buy stock, they are purchasing a share of ownership in a company. With futures, they are entering an agreement to buy or sell a specific asset at a set price on a future date. The asset could be anything from oil, corn, or even gold.
One reason why you might recommend futures to your clients is due to their flexibility. Futures contracts allow investors to take a position on the price of an asset without owning it directly. This can be useful for those who want to manage risk or take advantage of expected price movements.
For example, a farmer who is concerned about grain prices dropping might use a futures contract to lock in a selling price for their harvest. On the other hand, a bread company might buy that contract to secure its supply at a known cost.
There are two main types of participants in the futures market:
Both types of participants play a vital role in futures markets. The hedgers are the ones who help stabilize prices. Speculators, meanwhile, add liquidity to the market.
The standardized nature of futures contracts and the liquidity of regulated exchanges make it possible for a wide range of investors to get involved—not just large institutions. The futures market’s nearly round-the-clock trading hours and its focus on both short-term and long-term price prospects set it apart from traditional stock investing.
Futures trading is also suitable for those who want to take a more active role in managing their financial exposure. And this is why becoming knowledgeable about this type of derivative is beneficial. When you know how to explain the mechanics of futures contracts, you can help your clients understand the details behind these agreements.
Finally, if you’re also able to discuss the motivations behind different trading strategies, your clients will be able to see both the possibilities and the risks.
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