What are Futures?

First, we need to understand what Futures are in order to understand how to trade them. Futures are essentially standardized contracts that represent a certain amount, or quantity of an underlying asset to be transacted between two parties at an agreed upon price and date in the future. Let's unpack this with a simple example.

• A seller will have something they want to sell in the future. Maybe a wheat farmer who won't harvest their crop for another 3 months, but wants to line up a buyer.
• A buyer has something they want to buy in the future. Maybe a cereal producer who is trying to smooth out their supply chain by ensuring they have enough wheat in 3 months.

Both the buyer and seller could make an agreement to buy and sell wheat from one another in the future, but what if one of them backs out? What if one of them sells that contract to a neighboring cereal or wheat producer because of unexpected changes in the business? What if the wheat isn't of the agreed-upon quality?

Lucky for wheat and cereal producers, this has all been thought of before and is regulated by the U.S. Government in order to better facilitate efficient exchanges of goods.

Futures Contracts

Futures contracts are nothing but contracts that "derive" or more simply represent the value of an actual product, commodity, or financial instrument. They are characterized by:

• The date the transaction will be conducted
• Quantity or amount of the underlying asset
• Price per unit the transaction will be done at
• Guaranteed by an exchange ensuring buyers and sellers complete the deal

Because of this standardization and guarantee, they are easily exchangeable between parties. Meaning, they can be bought and sold nearly instantaneously between buyers and sellers, and are thus very tradable. Future Trading is the act of buying and selling futures contracts with the intention of making money on the price movements of the commodities or goods underlying the contracts. This sounds like a mouthful so let's unpack this.

Futures contracts were originally designed to help reduce the volatility of prices for goods being bought and sold. Examples included agricultural goods like wheat, corn, and cattle. They can also include other commodities like cotton or oil. Today, there are futures contracts that represent precious metals, currencies, even interest rates, among others. The point being, these are commodities or goods that are being bought and sold in large volumes around the world in the normal course of trade, and their prices move around.

Price moving around is normal and will fluctuate due to changes in supply and demand. However, because of the seasonality of consumption and other factors, sometimes prices move so violently that it inhibits global trade from actually occurring. The cereal producer and wheat producer never match up at the right time and both lose as a result. Futures contracts help reduce this volatility but still allow for price changes to occur over time due to changes in supply and demand.