Futures represent an agreement to buy or sell a specific quantity of a
stock, security, or commodity at a set price on a specified date in the
future. Short for "futures contracts," these agreements are legally
binding and must be fulfilled either by physical delivery or cash
settlement.
Here's what futures contracts are, how they work, and what you need to start trading them.
What Are Futures?
Futures markets trade futures contracts. A futures contract is an
agreement between a buyer and seller of the contract that some
asset—such as a commodity, currency, or stock—will be bought or sold for
a specific price, on a specific day in the future (the expiration
date).1
Futures trading is especially common with commodities. For example, if someone buys a July crude oil futures contract (CL),
they are saying they will buy 1,000 barrels of oil from the agreed
price upon the July expiration, regardless of the market price at that
time. The seller is likewise agreeing to sell those 1,000 barrels of oil
at the agreed-upon price. Unless either trades their contract to
another buyer or seller by that date, then the original seller will
deliver 1,000 barrels of crude oil to the original buyer.
These trades aren't confined to commodities, however. Traders buy
futures of stock in companies, foreign currency exchanges, index funds,
and more. Regardless of the product being traded, both the buyer and the
seller of a futures contract are obligated to fulfill its requirements
at the end of the contract term.2
- Alternate name: Futures contracts
Popular Futures Markets and Symbols
Futures contracts are traded on a futures exchange, such as the
Chicago Mercantile Exchange (CME) or Intercontinental Exchange (ICE).
Popular index futures, currency futures, and commodity-related contracts
include the following examples, all traded on the Chicago Mercantile
Exchange (CME):
- E-mini S&P 500 (ES) index futures
- E-mini Dow Jones Industrial Average (YM) futures
- Euro to U.S. dollar (6E) futures
- British pound to U.S. dollar (6B) futures
- 100 troy ounces gold (GC) futures
- 5,000 troy ounces silver (SI) futures
- 1,000 barrels crude oil (CL) futures
The symbol for the contracts is followed by another letter and number. The letter represents the month the futures contract expires,
and the number represents the year of expiration. For example, ES
contracts expire in March (code H), June (M), September (U), and
December (Z).3
For example, an ES contract that expired in December of 2019 would have
had a symbol like this: ESZ9. Some brokers and chart platforms may show
the last two digits for the year (ESZ19).
The expiration date of a futures contract is the final day that you
can trade the contract. Otherwise, it will be settled in cash or
physical delivery. This expiration date varies by contract but usually
occurs on the third Friday of the settlement month.4
How Futures Contracts Move
The price of futures contracts is constantly in motion. A tick is the
minimum price fluctuation a futures contract can make at any given
moment in the day. The tick size varies by the futures contract being
traded. For example, crude oil (CL) moves in $0.01 increments (tick
size), while the E-mini S&P 500 (ES) moves in $0.25 increments.5
Each tick of movement represents a monetary gain or loss to the
trader holding a futures contract. How much each tick is worth is called
the tick value,
and this varies by contract. For example, a tick in a crude oil
contract (CL) is $10 per contract, while a tick of movement in the
E-mini S&P 500 (ES) is worth $12.50 per contract.
To find out the tick size and the tick value of a futures contract,
read the contract specifications, as published on the exchange on which
the futures contract trades.
Day Trading Futures
Although much of futures market trading is done by those actually
doing business with the commodities involved, it is also a major market
for long-term speculators and day traders.
Day traders don't trade futures contracts with the intent of actually
taking possession of (if buying) or distributing (if selling), say,
physical barrels of oil. Rather, day traders make money on the price
fluctuations that occur after taking a trade, by means of a cash
settlement agreement, where money exchanges hands instead of goods. For
example, if a day trader buys a natural gas futures contract (NG) at $2.065, and sells it later in the day for $2.105, they made a profit.
Fees and Capital Required for Day Trading Futures
Trading a futures contract requires the use of a broker. The broker
will charge a fee for the trade, called a commission. Unlike stocks,
futures day traders aren't required to have $25,000 in their trading
account. Rather, they are only required to have an adequate day trading
margin for the contract they are trading (some brokers demand a minimum
account balance greater than the required margin).6
Margin is the amount a trader must have in their account to initiate a
trade. Margins vary by contract and broker. Check with your broker to
see how much capital they require to open a futures account ($1,000 or
more is typical), then check what their margin requirements are for the
futures contract you want to trade. This will let you know the bare
minimum of capital needed. However, you might want to trade with more
than the bare minimum you need, to accommodate for losing trades and the
price fluctuations that occur while holding a futures position.
Futures can be highly volatile and risky for day trading. If you
don't have capital that you can stand to lose, reconsider trading
futures. Always evaluate your risk tolerance before investing.
- Futures contracts represent an agreement to buy or sell a commodity, stock, or other security at the agreed-upon price on a set expiration date.
- They can be bought or sold repeatedly until the expiration date, at which point they will fulfill with cash or physical delivery of goods.
- Futures contracts are a way for supply chain actors to hedge against changes in market prices on goods, as well as a way that long-term investors and day traders can profit from these fluctuations.
- Day traders can profit greatly from futures trading, but the risks are substantial.
Futures vs. Options
One way that traders can manage risk on the futures market is by
buying futures options instead of outright futures contracts. These
options only execute if the market meets certain conditions.
For example, a trader might buy an option to purchase crude oil stock
if it rises to $40 per share (this is the strike price). If the stock
is currently trading at $38, then nothing will happen unless it hits
$40. Let's say a drop in supply causes crude oil to rise to $45. At that
point, the investor could exercise
their option to purchase shares for $40, then sell them at $45 and make a $5-per-share profit.
their option to purchase shares for $40, then sell them at $45 and make a $5-per-share profit.
| Futures Contract | Futures Option |
|---|---|
| Represents an obligation to buy or sell at the contracted price on the specified future date | Represents an option to buy or sell, but no obligation |
| Contract can be bought or sold repeatedly until the expiration date | Costs a premium |
| After the expiration date, contract is fulfilled with cash payment or physical delivery of goods | Only executes if the strike price is met before the expiration date |
| More risky | Less risky |