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XI. Future Basics

Futures futures futures. It seems that everyone is wanting to trade futures. The basics for a beginner trader really aren’t that difficult to understand or follow. They are a higher risk, higher reward, higher margin product if not used for hedging and done naked. But to break it down, it is just an agreement between two parties to buy/sell a certain product at a certain predetermined price at a predetermined price in the future. Not too complicated right? And there are only two kinds of futures: financials and commodities that are settled either at by cash or physical delivery. Not too many variables right? Well let me tell you as someone that has traded them for quite a while, there are a lot of variables that go into these positions. And so many nuisances to physical commodities when you are dealing with deliveries. I recommend that beginners steer away from a majority of the products and specifically do one product with buying and selling. Trying to use these to hedge your other positions , let alone trading a physical product with delivery that has basis , physical constraints and movement, and product specific can be quite the challenge for even most of the advanced traders. But if you must trade futures, I’ll go over how they work and how to make some money with them.

  • Stock Futures- are futures that trade off of a stock index and are cash settled

  • Maintenance Margin- a minimum dollar amount you must keep into your account to keep your position

  • Physical Delievery- the quantity, specs, and location a product must be delivered too

    • A small amount of contracts actually end up being delivered Nymex Nat Gas futures

  • Cash Settlement- the amount paid to the buy/seller net of the futures price differentiated buy the ending price of the underlying asset

  • Expiry- the date that the negotiated contract is set to end

  • ICE- Intercontinental Exchange

    • I have traded this exchange a lot and will focus on this a lot with physical commodities like natural gas

  • Contago- When the current spot price is less than the future price and results in a curve trending upwards

  • Backwardation- when the current spot price is higher than the future price and results in a downward trending curve

  • Future Options- are exactly the same as options on equities just with futures and allow a trader to get a delta close to 1

  • Currency Futures- futures related to currencies related to two specific currencies i.e USD VS AUS

    • This seems to be the most popular futures these days and an easy way to wipe out your account

  • Calendar Spread- the spread between varying expiration months on a future

  • Roll-Over - rolling at prompt contract expiration over to the next month to keep a position

  • Prompt Month- the closest month to expiring on a future

Just like buying equities and options, you are essentially taking a view on a future , hoping the product is going to either going to go up or down. The benefit of futures for most business parties is hedging when they own the underlying asset. For example, an oil production company is inherently long oil prices as they have to sell their product in the market. If they are worried about a price collapse, they might go sell a future in the market at a currently higher price ,locking in their spread between their cost of production and the sale on the the futures market. This means they have no downside risk if the price of oil crashes.

If you are just trading futures as a speculation, your benefit versus trading a normal instrument is that you can get better leverage, more liquidity , and lower execution costs. I prefer to trade derivatives in general over just buying equities (stocks) outright. It is honesty just personal preference, but is also on great way to hedge other parts of your portfolio. For beginning traders, you will enjoy the benefits of the leverage, but keep in mind the change in daily margin requirements where you may have to increase your account size to hold a position or your brokerage will automatically close your position. The major downside is the margin requirement, which if you don’t have access to more cash or aren’t managing your account size appropriately, you can get burned quite easily. This is why I recommend trading options over futures for most beginners who are looking to venture into derivatives .

Let me know if you have any questions. I will get into the strategies of futures in future posts and guides. Please visit my other guides, blogs, and videos for any questions. And don’t forget the Traveling Guides I also do on this site a joint encompassing of how I trade while I travel around the world.

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