What Are Futures in The Stock Market?

Futures contracts describe the underlying securities' amount and are standardized to facilitate trading on a futures market
Futures contracts are used to trade various commodities, currencies, and indices
Futures contracts allow parties to lock in a certain price and protect themselves from large price swings
Trading futures simply implies that the trader may expose himself to much higher prices of stocks than he ever could while purchasing the actual stocks

What’s The Meaning of Futures? - Definition & Explanation

Futures explained: A future is a standardized legal contract to purchase or sell something at a present value in the financial market.

Futures are financial derivative contracts that bind the participants to trade a commodity at a defined date in the future and value. Depending on the prevailing market price at the expiry date, the purchaser must acquire or sell the asset at the fixed value. Physical goods or other financial products are examples of underlying assets. Futures contracts specify the amount of the underlying securities and are standardized to allow trading on a futures market. Futures contracts could be used for hedge or trading. Futures enable investors to fix the price of underlying securities or commodities. These agreements have defined expiry dates and pricing that are known in advance. The month of expiration is used to identify futures contracts. The word "futures" refers to the total asset category used by retail investors. Nevertheless, there are a lot of different forms of futures contracts that are possible to be traded. Those Commodity futures types are various such as crude oil, Stock index including the S&P 500 Index, currency futures, and so forth. Futures markets are notorious for their use of excessive leverage. When using a leverage trading tool, the investor does not have to put up the whole of the contract's worth when engaging in a deal. Alternatively, the brokerage would demand an initial margin equivalent amount to a percentage of the whole contract value. In this article, we will further talk about what are futures in the stock market and how it works. Besides, we will also provide you with real examples that will help you better understand this trading concept.

How Do Futures Work? - With Examples

A contract is an arrangement to purchase or sell a certain amount of a stock, asset, or commodity at a predetermined price at a time in the future. Such agreements, abbreviated for "futures contracts," are enforceable by law. They must be satisfied either physically or by financial settlement. Futures contracts are used to trade various types of commodities, currencies, and indices. This provides dealers with a diverse range of items. Futures contracts are a profitable venture among day investors because they can be purchased and sold at any period of time when the financial market is open till the fulfillment date. While talking about futures meaning it should be definitely noted that Commodity futures trading is prevalent. For instance, if someone buys July crude oil futures, they dedicate themselves to buying 1,000 gallons of oil at the determined value when the contract expires in July, no matter what the market value will be at the end. Similarly, the seller agrees to sell the 1,000 barrels at the offered amount. If neither buyer nor seller exchanges their contract with some other buyer or seller before that day, the initial seller would provide 1,000 barrels to the original purchaser. If you want to find out what is the meaning of futures and what are the real-life examples of trading with them, we will provide you with more useful information in the next section.

Example of Futures Trading

We have already talked about how the futures operate in the stock market. However, let’s take some real examples in order to better understand the definition and the idea behind this concept. Futures contracts enable participants to lock in a certain price and safeguard themselves against the potential of significant price fluctuations (high or low) in the foreseeable future. Let’s suppose the fuel is a real-life display of how futures operate. To prevent an unanticipated spike in fuel price, the airline company may obtain a future contract to purchase a certain volume of jet fuel for distribution in the future at a predetermined value. A fuel supplier might sell a futures contract to maintain a constant demand for fuel and to defend themselves from sudden price drops. Both parties agreed on the conditions: To purchase 1 million gallons of oil for delivery in ninety days at a cost of $3 USD each gallon. However, not every trader in the stock futures market wishes to trade an asset in the future. These individuals are futures traders or speculators who take advantage of pricing variations in the agreement itself. If the value of the fuel increases, the futures contract becomes much more sensitive, and the holder of that contract may be able to sell it for a higher value on the futures market. Such investors can buy and sell futures without the intention of supplying the assets underlying the contract; they simply bet on price fluctuations on the market.

A Real Example of Futures Trading

Let us take a look at a real example of futures contracts and trading with them. On April 24, in the year of 2012, an incident happened that had a substantial impact on cattle prices. The United States Department of Agriculture verified the presence of Mad Cow Disease in a cow in the state of California. The fatal brain-wasting condition was found in the cow, according to officials. As a consequence, the value of live cattle fell to a 9 month low amid worries that the main four international importers of American beef — Mexico, Canada, Japan, and South Korea – will cease importing American beef. The event turned out to be a unique incident involving only one cow, and prices rebounded the next day.

How People Trade Futures on Stocks

A futures contract enables a buyer to bet on the path of market movements. If a trader purchased a futures contract as well as the commodity value climbed and was dealing above the initial purchase price at expiry, the investor would benefit. The purchase deal—the long trading position—would be mitigated or untangled with a sell transaction for much the same quantity at the existing value before the expiry date, essentially completing the long position. The disparity between both the prices of selected contracts will be paid upfront in the shareholder's trading account, and no actual goods will be exchanged. Nevertheless, if the commodity price value falls below the buying price indicated, there is a chance that the trader will lose a big amount of money eventually. It is indeed crucial to remember that trading on leverage enables a considerably greater stake than the trading account provides for. However, the noticeable thing is that the higher the leverage ratio the higher the risk the trader has to face while trading in the stock market.

Higher Leverage

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