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Is your favorite stock on a tear, but you don’t have enough money to buy 100 shares? Some investors in this situation turn to futures contracts to get more exposure to their favorite assets. Futures contracts allow a buyer to secure a fixed price for a fixed number of assets. This transaction goes through on the future contract’s expiration date. Futures contracts exist for many asset classes, such as commodities, stocks, currencies and others.
What is a Futures Contract?
A futures contract is a derivative that gives the buyer leveraged exposure to a commodity asset. Future contracts give the buyer the obligation to buy a specific asset at a set price on the expiration date. Sellers are obligated to sell the asset on the expiration date at the agreed-upon price. Buyers hope the asset’s price will increase during the contract, while sellers hope the asset’s price falls or stays flat. Farmers frequently use futures contracts to lock in prices for livestock and crops to avoid fluctuations.
Categories of Futures Contracts
Investors can choose from numerous futures contracts, but each of them is in one of the following categories.
Physical Futures
Physical futures involve the physical delivery of assets after the expiration date. Farmers who buy crop futures will receive crops at the end of the contract. Crude oil is another popular physical future, and each futures contract involves 1,000 barrels of crude oil.
Pros
- More investment opportunities
- Acquire a physical asset you can use right away
- Lock in a price for a volatile asset
Cons
- Not everyone has enough space for a physical delivery
- Shipping costs
- Leverage can hurt investors if the asset’s price moves unfavorably
Financial Futures
These futures focus on equities and other securities that do not require a physical delivery. You may receive stock, Treasury bills, CDs and other assets through financial futures.
Pros
- Leveraged exposure can increase your total returns.
- No need to worry about the asset’s physical delivery
- Can lock in a price
Cons
- Leverage can lead to higher losses due to unfavorable price movements.
- You must fulfill the contract at expiration. You cannot walk away from a futures contract at expiration like you can with an options contract.
6 Types of Futures Contracts
Investors can get exposure to several types of futures contracts. These are some of the top choices to consider.
Stock Futures
Stock futures allow you to lock in a price to buy or sell 100 shares of a stock. These contracts get exercised at expiry. Stock futures contract uses leverage to give investors more exposure to the underlying asset. Investors have to consider macroeconomic conditions and analyze the underlying stock. The underlying stock can perform differently from the broader market.
Index Futures
Index futures give investors extra exposure to indexes, such as the S&P 500 and Nasdaq 100. These indexes trade hands at expiration. Investors have to consider how the indexes allocate their funds across market sectors and individual stocks. The S&P 500 is a broader index that focuses on large-cap companies, while the Nasdaq 100 is a tech-oriented index fund that also focuses on large-cap companies.
Currency Futures
Currency futures let you lock in a price for a currency. The currency then swaps hands at expiration. Investors should consider each country’s fiscal policy, inflation, interest rate changes and other factors when assessing currencies.
Commodity Futures
Commodity futures give investors leveraged exposure to commodities like gold, livestock, crops and oil. Some of these commodities involve physical delivery, and the catalysts depend on the commodity. Investors have to consider weather, diseases, and other factors for livestock and crops. The factors influencing commodity prices are different for gold and oil.
Interest Rate Futures
Interest rate futures are derivatives that give investors exposure to changes in interest rates. When interest rates go up, the value of an interest rate futures contract will decrease. That’s because interest rate hikes make new debt more desirable, and old debt becomes less desirable in the process. This change leads to lower prices on existing bonds to compensate for the new rates being higher. However, declining interest rates can prop up an interest rate futures contract.
VIX Futures
VIX futures give investors leveraged exposure to market price volatility. VIX acts as a useful hedge when the stock market goes down. VIX tends to gain value as markets become more volatile.
Benzinga's Best Futures Exchange
Investors can choose from many types of futures contracts. They can choose from several assets and expiration dates, but it is important to choose the right futures exchange for your needs. These are some of the top futures exchanges to consider.
Diversify Your Portfolio With Futures Contracts
Futures contracts give investors leveraged exposure to various assets. You can choose to invest in physical or financial futures, and each of those categories has many sectors to consider. Investors should be aware of their risk tolerance and financial goals before opening futures contract positions.
Frequently Asked Questions
What are the 4 types of futures contracts?
The four types of futures contracts are equity futures, currency futures, commodity futures and interest rate futures.
What are futures contracts vs. options?
Futures contracts obligate the buyer and seller to exchange assets. Options contracts give buyers the right but not the obligation to request the seller’s assets. Both contracts have strike prices and expiration dates.
Can anyone buy a futures contract?
Anyone can buy a futures contract. You have to open an account with a broker that enables futures trading.
What is a lot in futures trading?
In futures trading, a lot is the standardized contract size for a commodity or financial instrument, representing the quantity being traded. It is determined by the exchange and affects minimum quantity, margin requirements and overall risk.