Futures represent an agreement to buy or sell a specific quantity of a stock, security, or commodity at a set price on a certain date in the future. Short for "futures contracts," these agreements are legally binding. They must be fulfilled by either physical delivery or cash settlement.
Many different commodities, currencies, and indexes are traded in futures. This offers traders a wide array of products. Since futures contracts can be bought and re-sold any time the market is open up until the fulfillment date, they are a popular product among day traders. Here's what futures contracts are, how they work, and what you need to start trading them.
Definitions and Examples of 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, known as the "expiration date."
Futures trading is 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, no matter what the market price is 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. 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 must fulfill its requirements at the end of the contract term.
- 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. The number represents the year of expiration. For instance, ES contracts expire in March (code H), June (M), September (U), and December (Z). 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 (ESZ21).
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 it usually occurs on the third Friday of the settlement month.
How Futures Contracts Work
The price of futures contracts is always 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). But, the E-mini S&P 500 (ES) moves in $0.25 increments.
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 varies by contract. For example, a tick in a crude oil contract (CL) is $10 per contract, but 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. These are published on the exchange on which the futures contract trades.
Day Trading Futures
Although much of futures market trading is done by those 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), for example, 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. Money changes hands instead of goods. For instance, 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.)
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. That will let you know the bare minimum of capital needed, but 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 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. Suppose 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.
|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|
- 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.