What Are Futures?

by Andrew McGuinness     Jul 16, 2019

For those of you new to the world of trading and investing, you might not be familiar with the term ‘futures’. If you are not a complete novice when it comes to the field of investing, it is likely that you either do know what this term means, or are able to decipher it through obvious context clues. If you aren’t up to the challenge of deciphering and would like a more exact clarification, a well-rounded lesson in trading 101 if you will, here are a few of the most important facts concerning futures.

1. Definition

Futures are contracts that require you to buy or sell a commodity, an asset, or any type of financial tool at a future time. This is to be done at a fixed price that has been decided upon before the transaction has been fulfilled.

2. The market

In order for futures to be successful, it is necessary for some predictions to be made concerning what’s to come. These predictions must obviously be somewhat accurate in order for any profits to result from futures. Making a successful prediction would involve predicting a drop in the market around the same time futures require their signers to buy assets at a higher price. Detecting a future market peak would lead to possible successful futures if those that have signed these contracts are obligated to sell their assets at a lower price.

3. Risk

Futures allow you to pursue less of a risky investment because of the fixed prices that you are obligated to pay at a later point in time. There is less risk involved due to the lack of an unexpected outcome with futures. The prices and time are both set upon signing futures, so you know what to expect.

Of course, you don’t know what the market will be like when it reaches the point in time that your futures obligate you to follow the transactions you have signed for. The market is the one unpredictable factor determining whether or not you made the best investment you could have with your allocated funds and will get the most bang for your buck.

4. Futures vs. options

The greatest difference between futures and options is the fact that futures require you to fulfill your obligations of either buying or selling at a certain point in time. Options, however, do not involve any contracts obligating you to follow through. Instead, options provide you with the ability to make an investment or sell an asset within a predetermined period of time. In other words, options give you opportunities with expiration dates attached to them while futures are contracts with obligated transactions to be fulfilled at a future point.

5. Hedging

Hedging is done in order to successfully avoid losses at all costs. Futures hedging makes it possible to keep the most reasonable financial outcome according to the current market price of an asset.

6. What to use futures for

Futures are not to be used for stocks, but are comparatively beneficial when it comes to commodities, indexes and currencies. This is because futures provide you with the upper hand by giving you leverage in the market. This high leverage allows investors to take part in the market in a way they would otherwise not be able to take part, mostly due to the usually higher risk involved with these assets. Markets that were once not available to shareholders become open to investors thanks to futures.

Get unlimited access to our Learning Center,
Broker Insights and Exclusive Promotions for Free!