Futures Trading 101: Understanding the Basics

Futures Trading 101: Understanding the Basics

Futures markets offer an excellent way for traders to express their views on different asset classes. For example, when shopping with S&P 500 you can establish a position in several ways – everything from ETFs (exchange traded funds) to opportunities forfutures.

The futures market is appealing as it offers significant amounts of liquidity in stock indices, raw materials, currencies, interest rates and selected cryptocurrencies. Futures are traded in a centralized way via regulated exchanges, offer flexibility to go long or short, have extensive trading times and allow leverage.

To trade futures, open an account with a futures broker where you place the trades, which are then directed to the exchange for execution. All this is done on the backend of your broker in the same way as how to trade stocks, optionsand FX.

Contract specifications

On the websites of the various exchanges that offer futures, you will find the contract specifications (“Contract Specifications”) with all the relevant details you need to know about the contract you are considering trading. The following are the most important details you should know.

Product code is the ticker symbol. For example, the product code of the e-mini S&P 500 futures contract is “ES”. Contract unit tells you how much of the ‘underlying’ contract represents and gives you a multiplier. For example, the ES contract has a total contract value that is $ 50 x S&P 500 price ($ 50 x $ 4150) = $ 207,500.

Trading hours varies from contract to contract, but most contracts these days trade for most of 24 hours over a 5-day week. However, this does not mean that liquidity is good during a 24-hour cycle, so you want to examine the various contracts and identify liquidity patterns. Liquidity is typically best during local opening hours.

Minimum price fluctuation tells you in what steps the contracts change and what they are worth. For example, WTI Crude Oil (CL) trading on NYMEX has a minimum price fluctuation of $ 0.01 per share. barrel, which is equal to $ 10. For every penny that moves crude oil, your profit and your loss on one contract will move up by $ 10. A $ 1 move in the price of WTI equals $ 1000 (100 cents x $ 10 = $ 1,000).

Listed contracts tell you which month or quarter the contract represents. Each month is indicated by a letter and can be found on the stock exchange’s website. For example, “H” is used for the month of March. So at the end of the code is the year. For example, if you trade with the e-mini S&P 500 contract from March 2021, the ticker symbol will be “ESH21”:

Settlement method informs you whether it is a supply (i.e. commodities such as oil) or settles financially (i.e. stock index futures). Traders do not stick to settlement, contracts are abandoned or rolled to the nearest first monthly contract.

Cessation of trade tells you when the contract is no longer trading. It is typically the third Friday in the expiration date, but varies by contract.

Futures Trading 101: Understanding the Basics

Margin and leverage factor

Margin and leverage are considerations of risk management, which is one of that most important factors for good trade. This is also where the perhaps biggest misconceptions lie about futures – that they are dangerous due to the available leverage and limited margin required to hold a position. But just because leverage is available does not mean you have to use it, and in fact, responsible trading involves using only minimal amounts of leverage. More on that just below, but first a few definitions to understand.

Margin is the amount of capital needed to buy or sell a futures contract. You can think of it as a deposit. It works in the same way as margin in other leveraged products, whether it is spot FX (“Forex”), stocks or another financial asset. In futures, there are two kinds of margins: initial margin and maintenance margin. That initial margin is the amount required by the stock exchange to enter into a position while maintenance margin is the minimum amount required in your account to continue to have the futures contract (s). If your account falls below the maintenance level, you may receive a “margin call” which will require you to add money to your account to bring the account balance back to the original margin level, or you may be forced to liquidate the position.

Typically, the margin rate will be between 3% and 12% of the total nominal contract value. For example, if the total value of a contract is $ 100,000 and the margin is 10%, only a $ 10,000 margin is needed to enter into a single contract. You will be able to get margin requirements from your futures broker.

It is obviously not ideal to trade with the margin, literally, so you want to make sure you are capitalized far beyond the margin requirements to ensure that your leverage factor is reasonable. For example, if a trader in an account with a cash balance of $ 10k buys a futures contract with a face value of $ 20k, the leverage factor will be 2: 1 ($ 20k fictitious contract value / $ 10k cash balance). The margin to enter the position may be only 10% of the contract value and the required margin will therefore be $ 2k. With an account balance of $ 10k, the trader is well capitalized beyond the margin requirement and demonstrates good risk management with a leverage factor of 2: 1.

Summary

  • Futures are traded on regulated exchanges and can be accessed through a futures broker in the same way as other markets such as stocks, options and currencies.
  • Contracts are available on all major asset classes; stock indices, commodities, interest rates and currencies
  • It is important to understand the contract specifications of the market you are trading with
  • Leverage is available, but remember that it must be used responsibly within a risk management framework