Trading futures can provide opportunities for a range of investors. Some investors may trade futures contracts in order to hedge against risk, or to speculate on the price movements of a given asset or security — or because their business will benefit if they lock in a commodity at a certain price. A large trucking company may buy oil futures as a way to protect itself against sudden spikes in the price of oil, for example.
A futures contract requires both parties to honor the terms, no matter what the price is in the market when the contract expires.
If you want to trade futures, there are various ways they can fit into your portfolio or plan.
What Are Futures?
Futures are derivatives that take the form of a contract in which two traders agree to buy or sell an asset for a specified price at a future date. Popular underlying assets for futures may include physical commodities like gold, corn, or oil, as well as currencies (including crypto), or financial instruments like stocks. The most commonly traded futures contracts use standardized terms, and are traded on a futures exchange.
For example, if you want to buy or sell corn futures, one contract would equal 5,000 bushels and be traded via the Chicago Board of Trade (CBOT). Oil is traded on the Chicago Mercantile Exchange (CME), and one oil futures contract equals 1,000 barrels of oil.
Traders buy and sell in increments specified by the contract. To buy 50,000 bushels of corn or 10,000 barrels of oil, you’d buy 10 contracts of each.
Given the quantities and dollar amounts of these trades, investors use leverage, thereby paying only a fraction of the total cost of the position (more on what margin trading is below).
Types of Futures
Futures contracts allow investors to make bets on the prices of a wide array of assets:
• Commodity futures, which allow investors to buy or sell physical goods like crude oil, pork bellies, natural gas, orange juice, corn, wheat, and more.
• Financial futures, including index contracts and interest rate or debt contracts.
• Precious metal futures allow investors to bet on the future prices of gold, platinum, and silver.
• Currency futures for fiat currencies like the euro, yen, the British pound, as well as cryptocurrencies.
• U.S. Treasury futures allow investors to make bets on the future value of government bonds.
What are stock futures? Like futures contracts where the underlying is a physical commodity, some futures are tied to shares of a single stock or ETF. Stock index futures, however, are tied to the price movements of an index like the S&P 500 index.
What are Futures Contracts?
A quick recap as we explore: What are futures, and how do futures work? First, a futures contract obliges the buyer to buy a certain asset, or the seller to sell an asset, at an agreed-upon price, by a certain date. Each party must fulfill the terms of the contract, no matter what the market price or spot price is when the contract expires (or trade the contract before the expiration).
Futures contracts are standardized, as noted above, and each contract also spells out the contract terms, which includes among other things:
• The unit of the trade (e.g., tons, gallons, bushels, etc.).
• The grade or quality of the commodity, where relevant. For example, there are different types of corn, oil, soy, etc.
• Terms of settlement (e.g., physical delivery or a cash settlement).
• Quantity of goods covered by the contract.
• Currency in which the contract is priced.
A futures contract allows investors to speculate on the direction of the underlying asset, either long or short, using leverage. (Leverage means the trader doesn’t have to put up the full amount of the contract. Instead, futures traders use a margin account.)
Recommended: How Does a Margin Account Work?
How Do Futures Work?
In order to answer the question, How do futures work?, it’s important to understand two key aspects of futures trading: hedging and speculation.
Hedging with Futures
Hedging is a big reason why investors buy futures contracts: It’s a way to protect against losses resulting from price changes in commodities.
Recommended: Why Is It Risky to Invest in Commodities?
Among the businesses that hedge using futures, the goal is to reduce the risk they face from unexpected price movements, and to guarantee the price they pay or receive for a particular asset.
If a large food manufacturer wants to lock in the price of corn, for example, they might enter into a contract for $10 a bushel. Since corn contracts are typically standardized at 5,000 bushels per contract, the total amount of the futures contract would be $50,000 ($10 x 5,000), to be delivered in six months. Entering into this futures contract would offer the buyer some protection against the possibility of rising corn prices in the future.
Let’s say the price of corn does rise to $12/bushel by the time the contract expires. In that case, the buyer still only pays the agreed-upon price of $10/bushel, even though the spot price is now $12/bushel.
For the corn producer in this scenario, even though it turned out that the futures contract terms weren’t quite as favorable as the actual market price — the contract guaranteed they would get at least $10/bushel, which provided a hedge against a potentially bigger loss.
Speculating with Futures
Although it’s possible to settle a futures contract for the physical asset specified in the contract, most futures contracts are cash-settled. That’s because speculation on price movements is one of the main reasons that investors purchase futures contracts. A futures contract gives traders the opportunity to speculate whether a commodity will go up or down and potentially profit from the price change.
If the underlying asset of the futures contract — such as gold, oil, or corn — is above the price specified in the futures contract, then the investor can sell that contract for a profit before it expires. In that case, the contract would sell for the difference between the market price of the underlying commodity and the purchase price as specified in the contract.
In such a transaction, the underlying commodities don’t change hands between the counterparties of the contract. Instead, the trade would be cash-settled in the brokerage account of the investor.
Alternatively, an investor using futures for speculation could lose money if the price of the commodity is lower than the purchase price specified in the futures contract.
Difference Between Options and Futures
There are other financial derivatives with similar characteristics to futures contracts. One of the most common of these is options contracts. American-style options grant the buyer the right, but not the obligation, to buy or sell the contract’s underlying asset at any time until the contract expires.
Unlike a futures contract, however, option contracts don’t require the investor to purchase or sell the underlying asset. The investor can simply let the option expire. A futures contract, on the other hand, obligates the buyer to purchase the underlying asset, or to pay the seller of the futures contract the cash equivalent of that asset at the time of the contract’s expiration.
Recommended: How to Trade Options
How to Trade Futures
It’s common for some brokerages to have their own futures-trading capabilities, as well as their own rules about what an investor needs in terms of assets in order to trade futures contracts. Be sure to verify what those requirements are before selecting a broker.
Once you’re eligible to open a margin account and trade futures, those contracts trade on different exchanges, such as the Chicago Mercantile Exchange (CME), ICE Futures U.S. (Intercontinental Exchange), and the CBOE Futures Exchange (CFE).
Most investors in futures contracts have no interest in either receiving or having to deliver the physical commodities that underlie these contracts. Rather, they’re interested in the cash profit. The means of doing so is to trade the futures contract before its expiration date.
The standardized nature of most futures makes it so that a great many (but not all) futures contracts will expire on the third Friday of each month. Some commodities are seasonal, and only trade during specific months. High-grade corn trades on the CBOT in March, May, July, September, and December, for example.
The Risks of Trading Futures
Owing to the nature of futures trading, i.e., the binding nature of the contracts and the use of leverage, there are some obvious risks to bear in mind.
In a speculative trade, a futures contract allows you to bet on a commodity’s price movement. If you bought a futures contract, and at expiration the price of the commodity was trading above the original contract price, you’d see a profit. However, you could also lose if the commodity’s price was lower than the purchase price specified in the futures contract.
The potential risks here can be greater than they seem, because trading on margin permits a much larger position than the actual amount held by the brokerage. As a result, margin investing can amplify gains, but it can also magnify losses.
Imagine a trader who has $5,000 in their brokerage account and is in a trade for a $50,000 position in crude oil. If the price of oil moves against the trade, the losses could far exceed the account’s $5,000 initial margin amount. In this case, the broker would make a margin call requiring additional funds to be deposited to cover the market losses.
Speculators can also take a short position if they believe the price of the underlying asset will decline. An investor would realize a gain if the underlying asset’s price was below the contract price, and a loss if the current price was above the contract price. Again, using leverage to place these bets, long or short, can potentially expose investors to more risk than they intended.
What are futures trading hours?
Unlike the stock market, which is active five days a week from 9:30 am to 4 pm Eastern Time, you can trade futures nearly 24 hours a day, six days a week — from 6 pm on Sunday to 5 pm on Friday — depending on the asset or commodity. Check local times.
Can you day trade futures?
Yes. Some investors believe that trading futures is well suited to day trading, as the price of the underlying asset determines the value of the contract, allowing traders to take either short or long positions, depending on the circumstances. Also, the Pattern Day Trading rule (often called the PDT) does not apply to futures traders, removing the $25,000 margin account minimum.
Can futures prices predict the market?
Not exactly, but futures can be an indicator of certain market movements. Owing to the global nature of today’s markets, there may be market activity overseas that could impact U.S. markets — but many investors wouldn’t know for certain until the U.S. stock market opened. Owing to that lag, some investors look to futures — which trade virtually 24/7 — to gauge possible market trends.
Are there futures in cryptocurrency trading?
Yes. Cryptocurrency futures operate much the same as other types of futures contracts. Traders agree to buy (or sell) a contract tied to an underlying cryptocurrency for a specified price on an agreed-upon date in the future.
Futures contracts allow traders to enter into a contract to buy or sell an underlying asset for a specific price at a future date. Futures trading offers investors the opportunity to hedge against the risk of price changes of certain assets and commodities, or to use futures contracts to speculate and potentially profit from those price movements.
Because futures contracts are generally liquid, they can be bought and sold up until the expiration date, which is a valuable feature for traders who don’t own or intend to own the physical asset.
Unlike trading most securities, the futures market is active nearly 24 hours a day, six days a week, allowing futures traders more opportunity and flexibility. But trading futures is not without risks. Because futures traders use leverage, that can allow them to place bigger bets on asset price movements, which can amplify gains, but exacerbate losses.
If you’re curious about futures trading, it’s a good idea to become familiar with the basics of investing. You could get started investing today by opening an online brokerage account with SoFi Invest®. SoFi Invest offers an active investing solution that allows you to choose stocks and ETFs, and SoFi does not charge a management fee. Becoming a SoFi member gives you complimentary access to a financial professional.
Photo credit: iStock/hopeist
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A., or SoFi Lending Corp.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected] Please read the prospectus carefully prior to investing. Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Advisory services are offered through SoFi Wealth LLC, an SEC-Registered Investment Adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at adviserinfo.sec.gov .