Futures Trading Education

Written by Jacey Harmon
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There are three main types of futures contracts: commodity, financial, and index. Commodity futures are those that deal with products such as corn, oil, livestock, and grain. Financial futures follow interest rates, stocks, and currencies. Index futures are linked to stock and commodity indexes.

A futures contract is an obligation to deliver the underlying commodity sometime in the future at a price determined today. For example, with a corn contract the seller agrees to deliver the specified amount of corn by the delivery date. In the case of financial and index futures, the seller agrees to deliver cash. Being able to deliver a commodity in the future, at the market's current price, allows producers to use futures to protect themselves from negative price movements. This type of futures trader is called a hedger and comprises a small portion of the futures market.

The majority of traders in the futures markets are speculators. Speculators are in the market solely to make a profit from price fluctuations. They accept the price risk hedgers are unwilling to take and have no interest in taking delivery of the underlying commodity. They also create liquidity in the market, which ensures price stability. To offset the obligation of the contract, a speculator simply places an offsetting trade.

Futures Quotes and Trading

Futures are traded on exchange floors. The first futures exchange in the United States was the Chicago Board of Trade (CBOT). Today, in addition to Chicago there are exchanges in New York, Kansas City, and Minneapolis. Each exchange trades specific commodities. The New York Exchange (NYMEX) specializes in energy commodities while the Kansas City Board of Trade focuses on wheat futures.

To buy a futures contract you must use a futures broker. It is highly recommended to use a Futures Commission Merchant (FCM). You can verify a broker's FCM status with the National Futures Association (NFA). The NFA is the regulatory agency in charge of overseeing futures brokers. With the high risk nature of futures contracts, it is imperative to use a reliable broker that will be able to place trades when you need them to.

To understand quotes for futures contracts you must know the specifications of the contract. The specifications clearly state deliver requirements and what each contract is worth. Each contract carries different valuation methods that are based on the contract's specifications. For example, a NYMEX sweet crude contract's value is based on the price of 1,000 barrels of crude. This is because the contract specifies each contract controls 1,000 barrels. Exchanges will have the specifications for each contract readily available for traders.

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