Futures Trading

1. Definition

Futures Trading involves financial contracts obligating the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and price. It is distinct from Spot trading, where the delivery and payment of assets occur immediately.

2. Background

Futures markets originally developed to manage the risk of price fluctuations in agricultural commodities. They allow producers (e.g., farmers) and consumers (e.g., manufacturers) to hedge against price volatility by locking in prices beforehand, ensuring stability regardless of future market conditions.

3. Key Features

3.1. Underlying Asset

The asset upon which the futures contract is based. * Commodity Futures: Physical goods such as crude oil, gold, corn, and copper. * Financial Futures: Financial instruments such as stock indices (S&P 500), interest rates (Treasury bonds), and currencies (Forex).

3.2. Leverage

Traders are only required to deposit a fraction of the total contract value, known as Margin. This allows for control over a large position with relatively small capital, amplifying both potential profits and potential losses.

3.3. Bidirectional Trading (Long & Short)

Unlike traditional stock trading, futures allow investors to easily profit from falling markets by taking a Short position (selling first), as well as rising markets by taking a Long position (buying first).

3.4. Daily Settlement & Expiration

Gains and losses are calculated and credited/debited to the trader's account daily based on the settlement price (Mark-to-Market). Since contracts have a fixed expiration date, maintaining a position requires Rolling over to a contract with a later maturity.

4. Risks

4.1. Margin Call

If the account value falls below the required maintenance margin level due to losses, the broker will issue a Margin Call demanding additional funds. Failure to meet this call results in the forced liquidation of positions.

4.2. Loss Exceeding Principal

Due to high leverage, a small movement in the underlying asset's price can lead to the total loss of the initial investment. In extreme cases, traders may lose more than their original deposit, resulting in debt.