Futures Contracts for Beginners: Learn the Basics


If you are thinking about investing your money on a sure-win situation, you should consider venturing on futures trading. Futures trading is essentially a way of doing business wherein all the business terms are stipulated in a contract, specifically the futures contract. All the pertinent information relevant to the trade can be found in the contract such as the unit price and the cash settlement, delivery date, and the means of delivery including the quantity and quality of the commodity ordered. In essence, a futures contract is an agreement between two individuals or parties to deliver and buy important assets and commodities such as lumber, oil, livestock, metals, and other underlying assets.



Benefits of Futures Trading

The good thing about getting into trade futures is that both parties are spared from uncertainty and it saves them from the trouble of haggling just to get the needed commodity or the underlying asset. Because of futures contract, the trader is secured that he will have his supplies after a specific period of time while the producer is sure that his assets will be disposed upon closure of the futures contracts. The parties and individuals involved in futures trading are categorized into two:



The hedgers are basically the producers, owners, and the consumers of a commodity who are interested in a certain underlying tangible or intangible asset. The main idea of hedgers is to be free from the risk of sudden price changes.

The speculators are the ones who try to make a profit by observing and calculating market moves and opening another contract called the derivative contract. The speculators have no direct participation in the delivery of the underlying asset; they are independent parties who seek to make a profit out of a futures contract. The spectators come up with a derivative contract and offer another related product being traded.

Tradable Assets

There are a lot of assets and commodities, whether tangible or tangible, that can be subjected to futures contracts. Most of these assets are the following:



Securities, such as individual shares

Interest rates and indexes

Currencies

Tangible commodities such as livestock and meat products; agricultural products like food, grains and fiber; forms of energy like natural gas, heating oil, ethanol and crude oil

Precious metals gold, silver, platinum; industrial metals such as nickel, copper, lead and iron; and rare metals

Environmental commodities

Bonds

Exchanges of Futures Contracts

Futures contracts are executed in different markets depending on your underlying asset. Nowadays, with the advent of technology, trade futures can already be done via the Internet. Online futures trading is convenient to most traders because they no longer have to go to a trading pit since an electronic trading system is already available. Futures contracts can be executed in the following financial settings:



Money market

Bond market

Foreign exchange market

Soft commodities market

Equity market

Security and Regulation

Futures contracts are being regulated by an independent regulatory board. Each contract has its own provisions, but it is the regulatory board that imposes sanctions on violated contracts.

Futures Trading Overview


With the advent of globalization, where the market for products and services have expanded from local to international and where governments have opened the capitalization of their domestic businesses including corporations to men and women who are non-resident or non-citizens of their countries, the concept of investment evolved to a more sophisticated level. This sophistication brought about the concept on futures trading and futures contracts.



Basic Elements of Futures Trading

To better understand futures trading, it is necessary to break down the definition into understandable basic elements. Futures are defined as:



What are they? They are standard contracts where the parties involved may not know each other.

Contracts to do what? Contract to either purchase or sell underlying instrument.

Purchase or sell what? A specific commodity or instrument, which is called the underlying asset and with quality that is pre-determined or standard.

Purchase or sell when? On a specific future date.

Purchase or sell at what prices? Current market price of the underlying asset.

Where can they be purchased or sold? Futures are traded-bought and sold-in an exchange market just like treasury bills, bonds, and shares of stocks. All cash settlements are done through the exchange market.

Understanding the Concept of Liquidity

Investment in real properties could be very inconvenient sometimes because they cannot be sold in a short period of time. When you need to convert them to cash, you need to find a buyer either on your own or through a real estate agent, and finding prospective buyers could be time-consuming and take a longer period of time than desired. Whereas if you invest your money in futures you could have your money back plus profits over a very short period of time because they are readily convertible to cash due to their high liquidity. Futures trading are very much desirable especially to those who would like to roll their money overnight because of the following standard features:



The underlying asset which could be an instrument such as foreign currency, bonds, or shares or stocks or a commodity such as gold, crude oil, coffee, or even sugar. Whatever the underlying asset involved, it is by nature valuable on its own and very easy to sell.

The settlement of the obligation could either be in cash or the delivery of the underlying asset.

The quantity or amount of the underlying asset that is to be delivered is fixed and even the quality is standard, thus whoever holds the futures is assured that even when their prices fluctuate their underlying assets' quantity and quality is fixed.