Futures involve a financial contract
that requires the buyer to purchase an asset (or the seller to sell an asset),
such as a physical commodity or a financial instrument, at a specific price on
a predetermined date in the future. Futures contracts detail the quality and
quantity of the underlying asset; they are standardized to facilitate trading
on a futures exchange. Some futures contracts may call for physical delivery of
the asset, and others are settled in cash. The futures markets are
characterized by the ability to use very high leverage relative to stock
markets. Futures can be used either to hedge or to speculate on the price
movement of the underlying asset. For example, a producer of corn could use
futures to lock in a certain price and reduce risk (hedge). However, anybody
could speculate on the price movement of corn by going long or short using
futures.
Investopedia explains Futures
The primary difference between
options and futures is that options give the holder the right, not the
obligation, to buy or sell the underlying asset until expiration, whereas the
holder of a futures contract is obligated to fulfill the terms of the contract.
In reality, most futures contract holders do not hold the contract to
expiration. In addition, if an investor were long in a futures contract, that
investor could go short the same type of contract to offset his or her
position. This serves to exit the position, much like selling a stock in the
equity markets would close a trade.
Option
What Does Option Mean?
Investopedia explains Option
Options are extremely versatile
securities that can be used in many different ways. Traders use options to
speculate, which is a relatively risky practice, whereas hedgers use options to
reduce the risk of holding an asset. In terms of speculation, option buyers and
writers have opposite views on the direction of the underlying security. For
example, because the option writer will need to provide the underlying shares
if the stock's market price will exceed the strike price, an option writer that
sells a call option believes that the underlying stock's price will drop
relative to the option's strike price during the life of the option, as that is
how he or she will reap maximum profit. This is exactly the opposite to the
outlook of the option buyer. The buyer believes that the underlying stock will
rise, because if this happens, the buyer will be able to acquire the stock for
a lower price and then sell it for a profit.
Commodity Futures Contract:
A standardized contract set by a particular futures exchange that includes the size (1000 barrels, 5000 bushels, 5000 ounces, etc.), the place where delivery can be made, the type and quality of the commodity to be delivered, and the price of the transaction. The futures contract is negotiated on a regulated futures exchange, which is a central market place where all buy and sell orders are routed to a single location on the exchange.
A transaction in the commodity futures market is made on the trading floor
(or in the trading computers) of the exchange between brokers who are members
of the exchange that particular commodity is trading on. The seller will have a
broker, and buyer will have a broker. They will then transact an order for a
purchase and sale.
The buyers and sellers of commodity futures contracts have obligations. The buyer is obligated to take delivery and pay for the cash commodity during a specific time frame. The seller is obligated to deliver the commodity, for which he will be paid the price that was decided in the exchange pit by the brokers. (Sometimes the price can be more or less depending on the grade (quality) of the specific material.) The buyer and seller can eliminate their obligation by offsetting their trade at the exchange before the contract comes due. This is what most speculators do in the commodity markets.
Most individuals who open commodity trading accounts are speculators looking to benefit off of the price movement of the commodity being traded. Farmers, oil operators, cattle companies, etc could open a commodity futures trading account looking to be a hedger and reduce their risk of price movement.
Example: The futures trader calls his broker and says "I would like to buy One March 2007 Corn futures at the Market Price." The broker would then take this futures order and relay this to the trading pit at the exchange, where the order would then be executed by brokers on the floor. (Sometimes conditions are present when the trade can not be executed for some reason which is rare but can happen.)
After the trade is executed, the floor broker would relay price paid or sold and relevant information back to the trader's broker. The futures trader's broker would then let the futures trader know the price that the Buy or Sell (the trade) was executed. In recent times, more trading has been done through the use of online futures trading, eliminating the use of telephones and calling of brokers on the telephones.
The futures trader can trade directly from their computer and have the trade routed directly to the trading floor of the exchange. At the exchange some orders (electronic markets) are executed immediately in the exchanges computers. This is becoming the more preferred method of trading because it tends to be quicker. Lets say the futures trader got his price back (the fill price) and he bought one March Corn at $3.10. He then watches the futures quotes and sees the price trading higher at $3.15.
He then calls his broker (or enters an order into his computer trading platform) to sell the futures contract he has bought earlier in the day. He tells his broker "I would like to sell 1 March 2007 Corn at the Market Price." The broker then relays this to the trading pit where the trade is executed and reported back to the futures trader. Lets say the price he received for the sale was $3.14.The futures trader bought a March Corn for $3.10 and sold a March corn for $3.14 One corn contact is 5000 bushels. Therefore, every one cent move in the price of a full size corn futures contract is $50.
The difference between the buy and sell was a 4 cent profit.The futures trader experienced a gain of 4 cents multiplied by $50, or a $200 move in his favor.Commissions and fees would be deducted from his buy and sell. Also bear in mind, had the price fallen, and the futures trader sold the corn at $3.06, he would have lost 4 cents,a loss of ($200) plus commissions and fees. And remember the risk of loss exists in futures trading. Sometimes traders execute trades numerous times a day and for numerous quantities.
Commodity Futures Contract:
A standardized contract set by a particular futures exchange that includes the size (1000 barrels, 5000 bushels, 5000 ounces, etc.), the place where delivery can be made, the type and quality of the commodity to be delivered, and the price of the transaction. The futures contract is negotiated on a regulated futures exchange, which is a central market place where all buy and sell orders are routed to a single location on the exchange.
The buyers and sellers of commodity futures contracts have obligations. The buyer is obligated to take delivery and pay for the cash commodity during a specific time frame. The seller is obligated to deliver the commodity, for which he will be paid the price that was decided in the exchange pit by the brokers. (Sometimes the price can be more or less depending on the grade (quality) of the specific material.) The buyer and seller can eliminate their obligation by offsetting their trade at the exchange before the contract comes due. This is what most speculators do in the commodity markets.
Speculators:
There are speculators and hedgers that trade in the commodity markets. (A hedger is not interested in making a profit off the movements in price of a commodity futures contract, but rather in shifting his risk of loss on the commodity itself due to adverse price change.) Speculators will buy and sell futures, or options on futures, for the purpose of making a profit. They will buy futures (a long position) when they think prices will rise, or they will sell futures (a short position) when they think prices will fall. Both the speculators and hedgers add volume to a market making it a more liquid market to trade.Most individuals who open commodity trading accounts are speculators looking to benefit off of the price movement of the commodity being traded. Farmers, oil operators, cattle companies, etc could open a commodity futures trading account looking to be a hedger and reduce their risk of price movement.
Trading:
Here is a simple example of a speculator (we will call him a futures trader) executing a trade and how it would work. Once the futures trader has established a futures trading account, he would then call his broker to initiate a trade. He would let the broker know if he was looking to buy or sell (long or short), the specific commodity he wants the trade in, the month and year of the contract he is looking to trade, the quantity, and the price which he is willing to buy or sell for (or he can say Market Order to have the trade executed at the current market price in the trading pit).Example: The futures trader calls his broker and says "I would like to buy One March 2007 Corn futures at the Market Price." The broker would then take this futures order and relay this to the trading pit at the exchange, where the order would then be executed by brokers on the floor. (Sometimes conditions are present when the trade can not be executed for some reason which is rare but can happen.)
After the trade is executed, the floor broker would relay price paid or sold and relevant information back to the trader's broker. The futures trader's broker would then let the futures trader know the price that the Buy or Sell (the trade) was executed. In recent times, more trading has been done through the use of online futures trading, eliminating the use of telephones and calling of brokers on the telephones.
The futures trader can trade directly from their computer and have the trade routed directly to the trading floor of the exchange. At the exchange some orders (electronic markets) are executed immediately in the exchanges computers. This is becoming the more preferred method of trading because it tends to be quicker. Lets say the futures trader got his price back (the fill price) and he bought one March Corn at $3.10. He then watches the futures quotes and sees the price trading higher at $3.15.
He then calls his broker (or enters an order into his computer trading platform) to sell the futures contract he has bought earlier in the day. He tells his broker "I would like to sell 1 March 2007 Corn at the Market Price." The broker then relays this to the trading pit where the trade is executed and reported back to the futures trader. Lets say the price he received for the sale was $3.14.The futures trader bought a March Corn for $3.10 and sold a March corn for $3.14 One corn contact is 5000 bushels. Therefore, every one cent move in the price of a full size corn futures contract is $50.
The difference between the buy and sell was a 4 cent profit.The futures trader experienced a gain of 4 cents multiplied by $50, or a $200 move in his favor.Commissions and fees would be deducted from his buy and sell. Also bear in mind, had the price fallen, and the futures trader sold the corn at $3.06, he would have lost 4 cents,a loss of ($200) plus commissions and fees. And remember the risk of loss exists in futures trading. Sometimes traders execute trades numerous times a day and for numerous quantities.
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