Introduction to the futures markets

Futures are a form of financial contract between a buyer and seller with the promise of delivery of goods or commodities at a future date for a specified price. The futures markets is as vast and ancient, dating back to early 1700’s in Japan where rice farmers used futures contracts to hedge their crops. From a trading or investing perspective, futures contracts can be traded the same way as stocks or forex and is subject to the same forces of supply/demand and technical/fundamental analysis. However, futures contracts do differ slightly in terms of the contract prices and the delivery dates and thus the name expiry date that is usually associated with any futures contracts.

How do futures work?

Futures contracts are primarily traded at the Chicago Mercantile Exchange, ICE or Eurex with CBOE amongst many being the clearing exchange. The futures market is made up of three main participants.

  • Commercials: This group is physically involved in taking or sending deliveries of the commodities and makes up a major portion of the futures market participants
  • Non-Commercials: This group is made up of large institutions whose primary purpose is speculative trading. They are not involved in taking physical deliveries of the commodities
  • Non-Reportables: This is the smallest group and is made up of speculative retail traders

The futures markets have many different commodities that can be traded. To name a few, it includes the following:

  • Precious Metals: Gold, Silver
  • Base Metals: Copper
  • Fuels: Crude Oil, Natural Gas
  • Commodities: Coffee, Grains, Soybeans, Corn etc

To gain a better understanding of how futures contracts work, let’s take an example:

A large shipping company needs to stock up on its Oil inventory for the next quarter. So they go to the futures exchange looking for Crude Oil delivery for June (CLM14). Of the many crude oil producers, they decide to buy 50 futures contracts of CLM14 at a price of $90 (they expect Oil prices to increase in the near term). The shipping company pays 50 contracts x $90 = $4500 and expect delivery of (50 x 1000 barrels = 50,000 barrels) in June.

The above transaction is nothing but a futures contract.

Because the futures market is made up many different commodities, the units or tick varies from one commodity to another. For example, the default unit for Crude Oil is 100 barrels,

Futures expiry dates

Every futures contract that is traded comes with an expiry date. They are designated with the following expiry codes also known as the delivery month.

 

Month Futures Code
January F
February G
March H
April J
May K
June M
July N
August Q
September U
October V
November X
December Z

 

So for example, if you are trading Crude Oil with delivery of June 2014, the contract would be designated as CLM14, where CL stands for Crude Oil, M for June Delivery and 14 designates the year 2014.

Figure 1: Crude Oil Futures CLK14

Trading Futures? Some tips

If you are interested in trading futures, there are some important points to bear in mind.

Tick size: The tick size or the minimum unit of change varies from one commodity to another. The tick value therefore changes as well. It is essential to know the tick size and tick value before you trade futures so you have enough margin and capital to cover the fluctuations.

Delivery Dates (Contract Expiry): If you are trading futures electronically, be sure to check how the expiries are dealt with. Some brokers simply close the contract at market when a futures contract expires. Other brokers tend to rollover the futures contract into the next month.

Trading Times: Futures are traded at different times and therefore not accessible 24 hours a day. Be sure to check on the futures trading times and days to plan accordingly.

Fundamental Reports: Futures markets too are subject to basic fundamentals such as Crude Oil inventory reports, USDA Grains report, Natural Gas storage reports. These are market moving events and thus one should understand them correctly.

Contract Volatility: When a new futures contract gets underway, initially it is very volatile due to lack of liquidity. Price can gap up and down causing wild spikes. It is therefore essential to take note of this and trade only those contracts that have enough liquidity to prevent such wild moves.

Trading Futures on MT4

If you are trading futures contracts on the MT4 trading platform, you can easily look up all the info you need. Simply click on the ‘Marketwatch’ window, right click to select ‘Symbols’ and expand the folder Futures to see the list of futures instruments available to trade. Right click on any futures symbol to get complete details such as tick value, tick size, swaps and expiry.

Figure  2: Futures Specifications, MT4

 

 

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