Are you a beginner in the trading world and want to learn about futures trading? If YES, then you are at the right place; after reading this post, you will get a comprehensive idea about the future and what benefits you will get.
What is Futures Trading?
Futures trading, also known as futures financial contracts, allows two parties to sell or buy assets at a fixed future amount and date. A buyer has to buy, and the seller has to sell the fundamental asset at the set price. Futures contracts have expiration dates and also fixed prices known as upfront.
The fixed prices of the contract are irrespective of the present market price at the expiration date. Future contracts are recognized by their expiration month. For instance, a January gold futures contract expires in January.
However, the buyer party of a futures contract is gratified to take ownership of the underlying asset at the time of the end of the contract and not any time before. The buyer party of a futures contract can sell their position at any time before expiration and be free of their obligation.
Futures Contract Example
Suppose a trader wants to wonder about the price of wheat to enter into a futures trading contract in June with the expectation that its worth will be increased by the end of the year. The December wheat futures contract at $30, and the traders buy the contract.
Wheat is traded in rises of 1000 bushels, and the investor has a position worth of wheat of $30000 (1000 x 30 = $30000). However, the trader will only have to pay a portion of the amount up front (the initial margin that they deposit with the broker).
The price of wheat oscillates, as does the worth of futures trading from May to December. If prices of wheat get too unstable, the broker may require to ask that further funds be deposited into the margin account, also called the maintenance margin.
The end date of the contract is approaching on the third Friday of December if the price of wheat has increased to $50. The trader sells the original contract to depart the position, and the net difference is cash settled. The seller gross is $20000 ($50 – $30 = $20 x 1000 = $20000) less any charges owed to the broker. Meanwhile, if the price of wheat had dropped to $20, then the investor would have lost $10000 ($30 – $20 = $10 x 1000 = $10000).
Types of Futures Trading
A trader can trade in a wide range of Futures contracts, including financial and commodity, currencies, indexes, metals, energy, and livestock. Here, we have shared the types of available futures contracts.
1. Financial Futures
Two types of financial futures are available to trade, including index contracts and debt rates. Index rate contracts offer exposure to a certain index market value. However, interest rates offer exposure to the interest rate of a specific debt instrument.
- Mini Dow Jones
- Micro E minis
- E-mini-S&P 500
- E-mini-Russell 2000
- E-mini-Nasdaq
- E-miniāMid Cap 400
- Volatility indexes
- Bloomberg Commodity Index
- Ultra Bonds
- US Treasury Bonds
- Nikkei 225 (CME)
- Eurodollars
- US Treasury Bonds
- US 2-, 5-, or 10-years Notes
2. Currency Futures
The currency contracts offer exposure to the exchange rate of an actual currency or cryptocurrency.
- British Pound
- Euro
- US dollar Index
- Australian Dollar
- New Zealand Dollar
- Canadia Dollar
- Japanese Yen
- Swiss Franc
- Korean Won
- Mexico Peso
- South African Rand
- CME Bitcoin
3. Metal Futures
Metal futures trading offers exposure to the charge of certain metals that many companies depend on as materials for industrial and construction.
- Platinum
- Gold
- Silver
- Copper
- Palladium
- HRC Steel
4. Energy Futures
Energy contracts offer exposure to the charges of common energy products. Companies use these products for transportation production and industrial purposes, and the public also uses them for feeding.
- Natural Gas
- Gasoline
- Crude oil
- Heating oil
- Brent crude oil
- Ethanol
5. Livestock Futures
Livestock future trading contract offers exposure to the charges of live animals that are used in the supply processing of meat products.
- Lean Hogs
- Live cattle
- Feeder cattle
6. Fiber and Food Futures
Fiber and food futures contracts offer exposure to the charges of specific dairy and farming products that are grown and also mined.
- Cotton
- Wood
- Sugar
- Cocoa
- Milk
- Cheese
7. Grain Futures
Grain Futures contracts offer exposure to the charges of raw grain materials used for animals and marketable processing into other products.
- Rice
- Corn
- Wheat
- Soybean
- Soybean Oil
- Soybean Meal
- Oats
Why Should You Trade Futures?
Every trader and investor most usually opt for futures as a way to speculate on the future price movement of the underlying asset. They express their opinion about where the market may be headed for a certain commodity index or financial product to get a profit.
However, some investors also use futures trading as a hedge to help offset future market moves in a particular commodity that might impact their business. While there are some risks, a trader and investor need to be aware. But there are also some benefits of the futures market offers that the equities market does not.
1. Tax Benefits
Futures contract offers tax benefits as compared to other short-term markets. It is taxed on a 60/40 basis: 60 percent of profits are taxed as long-term capital gains and 40 percent as ordinary income. Whereas in stock trading profits on stocks held less than a year are taxed 100 percent as ordinary income.
2. Leverage
Establishing an equity position in a margin requires payment of 50 percent or more of its complete value. At the same time, futures require an initial margin amount that is usually set between 3-10% of the underlying contract value. That leverage allows a trader to generate larger returns relative to the amount of money invested.
3. Diversification
Futures trading offers a few ways to diversify your investing and give you direct market exposure to underlying commodity assets. Moreover, they let you access specific assets that are not usually found in other markets. It also helps you to design strategies to manage some risks surrounding upcoming events that could move the markets.
4. Short Selling
In the futures contract, the margin requirement will be the same for long and as well as short positions. It enables a bearish position reversal without additional margin requirements.
5. Limited Downside Risks
Another reason for trading futures is that you can speculate your profits, but they can be used to hedge your risk. Suppose you expect the market to correct by 10-12 percent; however, you believe that it would be temporary and markets would recoil back. In this situation, just hold on to your stocks and sell Nifty futures against that. Once the market corrects, you sell the futures, and the profits will help you to reduce the cost of holding your cash market position.