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What are Futures?
What Are Futures?
Futures are contracts for cash settlement or the physical delivery of goods. Below are three main characteristics of futures trading.
- Easy contract trading: Futures contracts are traded on an exchange. Whether you buy or sell a contract, closing the trade is similar to stock trading.
- Settlement by physical delivery or cash: Similar to stocks, most futures contracts settle in cash. There is no delivery of physical goods or shares of stock, only cash. On the other hand, some commodity futures such as corn or soybeans are settled with physical goods. At expiration, both parties of the contract are expected to either receive or deliver the commodity being traded.
- Backed by commodities or other assets: The pricing of futures contracts are based on the prices of agricultural products (ex. cattle and wheat), energy products (ex. gasoline and crude oil), or financial products (ex. those impacting the currency exchange and interest rates).
How Do They Work?
Similar to stock trading if you purchase a futures contract and the price goes up, you have made a profit. Likewise, if you short a futures contract and the price goes down, you have made a profit. Below are several basic terms of futures trading and how a contract is valued.
- Tick: The minimum price increment of a futures contract is called a "tick". The tick value is different depending on the instrument being traded. For example, the tick size of a E-mini S&P 500 contract is a quarter of an index point.
- Tick value: The tick value is also different depending on the instrument being traded. As opposed to stocks where each tick is $0.01, each tick of a futures contract varies. The E-mini S&P 500 contract for example, has a tick value of $12.50. This means that if you purchase one contract and sell it when it goes up 10 ticks, you would make a profit $125.00.
- Contract size: Each futures contract represents a specific quantity of a commodity or financial instrument. GC gold futures contracts, for example, represent 100 troy ounces of gold.
- Notional value: The contract size allows you to figure out how much each contract is worth. You can determine the notional value by multiplying the current price of the futures contract by the contract size. For example, if gold was trading at $1,500 per ounce and the size of the GC gold futures contract is 100 ounces, the notional value of the contract would be $150,000. Fortunately for us, the futures markets are highly leveraged. We do not have to put up the full contract amount to enter a trade.
- Margin Requirement: Each broker has their own set of rules surrounding margin requirements. You can learn more about NinjaTrader's margin requirements by following this link. https://ninjatrader.com/Margins-Position-Management