Futures

Definition: Futures are forward contracts for a specific commodity. Futures contracts on commodities are called commodity futures, while those on shares, bonds, indices, and currencies are called financial futures.

Depending on whether they are short or long positions, they oblige the purchaser of the contract to deliver or buy a certain quantity and quality of the underlying instrument at a specific time in the future at a price fixed at the end time of the contract. The seller of the contract is subject to the same obligations.

The parties can only avoid these obligations by reselling the contract, which is called closing the position. Futures are usually purchased on margin. This means that the buyer does not pay the agreement's total value but only makes a margin deposit or security deposit. This margin deposit is variable. If the margin, i.e., the ratio of collateral to contract value, increases during the contract term, the buyer usually receives an interest credit. The broker can generally demand additional payments or close the position if the margin decreases.

Where Can Futures Be Traded?

Futures are traded exclusively on futures exchanges and futures markets. The largest U.S. options exchange is the Chicago Board Options Exchange (CBOE). It has an annual trading volume that hovered around 1.27 billion contracts at the end of 2014.

CBOE offers over 2,200 companies, 22 stock indices, and 140 exchange-traded funds (ETFs). The settlement of the futures contracts via the exchange guarantees transparent trading and fair pricing. Incidentally, the initial margin for futures contracts is deposited at the exchange where the contract is traded.

Example: Futures for Price Hedging

A potato chips factory has a potato demand of 2000 tons and wants to buy potatoes in the future for $100€ per ton. Futures on potatoes are offered at one ton each. If the potato chips factory now wants to secure its entire demand, it must buy 2000 futures on potatoes.

In this example, the contracting party, i.e., the counterparty of the potato chips factory, can be anybody since the trading of the futures is standardized and settled on the exchange. Therefore, the potato chips factory does not have to agree with a specific potato farmer, and the potato chips factory can buy directly on the exchange.

For example, if the potato chips factory's counterparty is a speculator, the speculator must ensure that he can deliver the promised goods at the end of the contract.

Are Futures Interesting for Private Investors?

On the one hand, futures serve as hedging transactions for companies that want to secure future prices. On the other hand, they are nowadays mainly used for speculation. The number of traded derivatives exceeds the volume of available commodities many times over.

Thus, there are more derivatives on underlying assets than underlying assets available. This leads to the market for particular commodities being artificially inflated, which can adversely affect the economy and the people who depend on these commodities.

Investing in futures requires a high degree of market knowledge, risk awareness, and financial reserves on the investor side. Therefore these financial instruments are not recommended for beginners, and there is no possibility of risk limitation as there are certain types of certificates with futures.