Futures Trading Introduction

A future contract is an obligation to buy or sell an asset at a later date at an agreed-upon price. Future contracts are a true hedge investment and the most understandable one in terms of commodities like corn or oil. For instance, a farmer may want to lock in an acceptable price upfront in case market prices fall before the crop can be delivered. Producers like oil producers could enter a short position to lock oil prices for the next quarter to assist their production plan.

Futures trading magnifies the profit and loss (PNL) by the factor of leverage (inversed initial margin ratio). Let's take a long position of crude oil with a 5% margin or with leverage of 20 for instance. If the market went up by 2.5%, this position gets a 50% return; while the position loses 50% if the market went down by 2.5%.

Futures are an important financial derivative tool as they allow traders to trade more market value with fewer funds. Futures trading happens on exchanges, which enforces the required regulations, ensures orders execution, risk management, and deliveries.