For newer traders, futures contracts may seem like a complicated market reserved only for experienced traders. But futures are just like any trading instrument. Once you learn the terminology and characteristics of the market, there’s really nothing to be intimidated of. Here’s an overview of what every trader should know about trading futures.
At its core, a futures contract is simply an agreement between two parties, just like any other contract. Much like options contracts, futures contracts are agreements to buy or sell a specific asset at a specific price on a specific date in the future. However, the major difference between options contracts and futures contracts are that futures contracts come with an obligation to execute the contract, whereas options contracts merely give the buyer the right, or “option,” to execute the contract.
In other words, if you understand option trading, you probably already understand the major principles of futures trading as well. Options buyers pay a premium for the right to decide whether or not to exercise the contract, whereas futures contracts have no up-front premium.
Futures exist for many different types of securities, such as stocks, indices, and currencies. Lightspeed offers many different types of futures contracts, ranging from agricultural commodities like corn, oats and rice to futures on indexes such as the S&P 500.
Like stock tickers, futures contracts have codes, such as “ZC” for corn futures. After the abbreviation ZC, the code will be followed by a third letter of the alphabet that denotes the month the contract expires. Finally, the code will have a number denoting the year the contract expires.
Learning the letters associated with each month is the most tricky part. They monthly letters are included in the following chart:
|F = January||J = April||N = July||V = October|
|G = February||K = May||Q = August||X = November|
|H = March||M = June||U = September||Z = December|
For example, a corn futures contract corresponding to November 2018 would have the code ZCX8 or ZCX18.
Once you know the symbol, the final thing to understand is the tick value of the futures contract. Each corn futures contract represents 5,000 bushels of corn, so a 1-cent increase in the price of a bushel of corn represents a $50 increase in the value of each corn futures contract.
Like options, futures trading requires margin and a margin account. To keep things, Lightspeed lists the Initial Margin Requirement (IMR) and the Maintenance Margin Requirement (MMR) for each futures contract type. Federal Reserve Regulation T sets the IMR for a futures contract purchase at at least 50 percent of the value of the contract. Once the trade is executed, the MMR is the minimum amount of margin that is required to maintain the open position, which is at least 25 percent of the value of the position.
Finally, traders must understand the type of settlement that comes with the futures contract. Commodity futures often come with physical delivery settlement. That means buying and holding one corn futures contract with physical delivery will land you 5,000 bushels of actual corn if the contract is not sold prior to being executed.
Other contracts are executed in cash value settlement only, which is likely preferable for most traders willing to hold until the execution date.
Lightspeed makes trading futures essentially as easy as trading stocks. Once you can read and understand futures quotes, simply populate the same order window used for stock trading with the futures contract symbol, the number of contracts and the price, and then click “buy” or “sell.”
For more information on fees and futures market trading hours, visit Lightspeed’s futures trading resources page here.
Disclosure: The author holds no position in the stocks mentioned.
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