Introduction to futures

The value of your investments and the income you receive from them can go up and down, and you may get back less than you invest. Any examples are for illustration purposes only.

Welcome to the futures market, a dynamic and essential part of the global financial system. Futures are contracts between two parties to buy or sell something at a set price on a specific date in the future. Hence the name, “futures”. They've been around for a long time, helping businesses and investors manage risk. In fact, that’s why futures exist - to help businesses, farmers, merchants and investors manage the risk of changing prices.

If you’ve already traded stocks, exchange traded funds (ETFs), or options, many of the basics will be familiar to you. For example, futures trade on exchanges, have bid and ask prices and can be bought or sold. For every market participant looking to manage risk, there’s usually a trader or “speculator” on the other side looking to take risk. Futures traders rely on a combination of market analysis, risk management and quick decision-making to speculate on anticipated price movements.

Like other forms of active trading, the goal is typically the same - to buy low and sell high. Or, if you’re feeling bearish, sell high first, and then buy low later. While there are similarities, futures aren’t the same as stocks or options and have different rules and mechanisms that facilitate their trading, among other key differences. Because futures are powerful, levered products they can lead to both large profits and large losses. As a self-directed trader, be sure to educate yourself before making your first futures trade. As you begin your journey, we’re here to help.

Futures markets have a long history, dating back to ancient times when farmers and merchants used them to lock in prices for crops, protecting themselves from price fluctuations. In the 17th century, Japan developed an early version of futures contracts for rice traders, allowing them to buy or sell at a set future price. This helped reduce risk for both buyers and sellers by ensuring stable prices.

The modern futures market took shape in the mid-19th century in Chicago, where the Chicago Board of Trade (CBOT) was founded in 1848. It allowed farmers to secure income by locking in prices for their crops before harvest, and buyers gained confidence in supply and pricing. Over time, the market grew beyond agriculture, encompassing commodities and even financial instruments like stock indices and interest rates.

In 2007, the Chicago Mercantile Exchange (CME) merged with the Chicago Board of Trade (CBOT) to create the CME Group. This was followed by the acquisition of the New York Mercantile Exchange (NYMEX) and the Commodity Exchange (COMEX) in 2008, which allowed the CME Group to expand the trading of commodities like energy, metals and agriculture. In recent years, the CME Group has expanded into cryptocurrency futures, offering Bitcoin and Ether contracts.

Today, futures trading is mostly electronic, making futures markets more accessible and efficient worldwide. Futures continue to play a vital role in the global economy, providing businesses and investors with a platform to manage risk and hedge against price changes. While it has expanded in scope, the core purpose remains the same - helping people plan for the future by reducing uncertainty and stabilising prices.

Futures are exchange-traded contracts that represent agreements to buy or sell an asset at a specific price at a future date. Contracts are standardised in terms of the contract size, expiration date and hours of trading, and are available on a variety of different asset classes. These are called contract specifications, or specs, and are important to know before you trade. WTI Crude Oil futures (/CL), for example, represent an agreement to buy or sell 1,000 barrels of crude oil. If oil futures are currently trading for $80 per barrel and a trader believes prices will move higher, they might buy the futures contract. If they think the price of crude oil will fall, they could sell a futures contract. At expiration, the buyer would pay cash and the seller would deliver the crude oil through methods prescribed by the futures exchange at the previously agreed upon price of $80, no matter where the current market price (also known as the “spot” price) of oil is.

While the idea of taking delivery of 1,000 barrels of crude oil might sound intimidating (nobody wants that in their backyard), in practice, most futures traders have no intention of taking or making physical delivery at expiration. In fact, many futures brokers don’t even allow their customers to do so. Only a small fraction of market participants, known as “commercials”, such as businesses, commodity brokers, and farmers actually use futures contracts to facilitate the delivery of goods and commodities.

It’s also worth noting that futures aren’t options and options aren’t futures. While both types of contracts have expiration dates, futures are a binding agreement to purchase or sell an asset, whereas options provide the buyer the right, but not the obligation to act. Futures do not have strike prices, implied volatility or greeks. That said there are options on futures contracts, but they aren’t the same as the underlying futures contracts themselves.

Trading futures shares several key similarities with stock trading. In both cases, the goal is to open a position and close it at a profit, whether by buying low and selling high or selling high and buying low. This core strategy mirrors stock trading, but futures come with distinct features, such as contract expiration dates and the potential for leverage, which can amplify both gains and losses. Despite these differences, the objective remains the same: capitalising on price movements to generate profit.

However, unlike stock investing, where assets are often held for the long term, futures trading typically focuses on short to medium-term price movements. Futures contracts aren’t designed as long-term buy-and-hold assets, as they eventually expire. The use of leverage in futures trading also introduces a level of risk that may be unfamiliar to stock investors, making effective risk management a crucial part of any successful futures trading strategy.

Futures can offer a number of advantages to traders and investors. While not an exhaustive list, here are some of the advantages of using futures contracts:

1. Direct exposure to an underlying asset: Compared to stocks or ETFs, futures provide more direct exposure to specific assets like metals, energy and currencies. For example, shares of an oil company will likely react to changes in oil prices, but won’t move dollar-for-dollar with the underlying price of oil. Not to mention, there are other considerations for why the stock price of an oil company would move up or down.
2. No pattern-day trading (PDT) rules: Stock and options traders who do four or more day trades in a five trading-day period are subject to PDT rules and are required to keep a minimum account balance of $25,000 or more. With futures, there are no limits on day trading.
3. Leverage: Because futures trading requires a smaller upfront cost, you can leverage more of your money to trade them than you can with stocks. This allows you to control larger amounts of the underlying asset with a smaller amount of your own money. Note: this is also one of the risks when trading futures as leverage can amplify losses as well.
4. Liquidity: Futures are a global marketplace and trade nearly 24 hours a day, Sunday to Friday. As a result, many futures contracts have high liquidity, allowing for efficient trading and tight bid-ask spreads.
5. Go long or short: Traders can buy futures when they expect the price of the contract to move higher and sell short when they expect it to fall. While stock traders can also sell stock short, brokerages may charge interest to borrow stock for short selling and the stock also has to be available to borrow, which may not always be the case. The so-called borrowing rate doesn’t apply to shorting futures contracts.
6. Capital efficiencies: Margin requirements to open a futures position are typically 3-12% of the contract’s notional value, allowing traders to more efficiently use their trading capital. This is the source of futures leverage.
7. Portfolio diversification: In addition to stock indices, futures are available for assets like energy, currencies, metals and crypto, which offers the ability to trade asset classes that aren’t necessarily available on the stock market.
8. Standardisation and regulation: Futures trade on regulated futures exchanges as standardised contracts, which means the terms of contracts are determined by the exchange, and investors know exactly what terms they’re agreeing to.

While futures have many advantages over other asset classes, they also have trade-offs and come with plenty of risks. While not an exhaustive list, here are some of the cons of using futures contracts:

1. Leverage: Yes, this isn’t a typo. Leverage can be both an advantage and a risk. The ability to generate relatively large percentage gains on small percentage moves in a commodity or other asset introduces the potential for large profits as well as large losses.
2. Risk of losses: When trading futures, you can lose more money than your initial investment, known as the initial margin requirement. In the event that trading losses trigger a futures margin call, you’ll be required to deposit more money or close your position. If you fail to meet your margin call, your broker might close part or all of your position.
3. Futures ≠ ownership: When you buy a stock, you purchase a share of the company's equity and may receive dividends and voting rights, which isn’t the case with futures.
4. The learning curve: It can take some time to get familiar with the different futures products. There’s a learning curve to futures trading because it requires an understanding of all the contract specs that go along with a specific contract.
5. Less flexibility: Compared to options, strategies with futures are more limited. Options can be used in a variety of ways: to profit from upswings, declines, sideways markets, changes in volatility, or time decay, but come with complexities of their own.

Step 1: Learn the basics. Start by understanding how futures work, including key concepts like leverage, margin, contract sizes, expiration and the risks involved. You can find educational resources here on Robinhood Learn and on our YouTube channel. In addition, please reach out to our support teams with any questions you may have.

Step 2: Identify a market and futures contract that interests you. Futures can be traded on a variety of assets like commodities (oil, natural gas, gold, silver, etc.), stock indices, crypto and currencies. Decide which market you want to specialise in based on your interests and knowledge. While stock traders often focus on many individual companies, futures traders are more likely to specialise.

Step 3: Open your futures account. Trading futures requires an approved trading account with a futures broker.

Step 4: Develop a game plan. It’s important to develop a trading plan before you make your first trade. Create a strategy that outlines your goals, risk tolerance and methods for analysing the market. This will likely include risk management techniques in an attempt to protect against large losses. Are you trading off news events, or charts, or a combination of both? If you know when to open a trade, do you know how to manage an open position, and do you have a plan for when to close it? All important questions you should ask yourself before you make your first trade.

Step 5: Learn the contract specs and understand the futures margin requirement. Knowing the key details of the contract that you want to trade and the margin requirements is a crucial step in trading futures. Each futures contract has its own contract specifications and margin requirements and, as you move from one contract to the next, you’ll need to be familiar with the particulars of that new contract.

Step 6: Take your time, start small. Don’t rush into trading a large position. Futures are leveraged products and even a single contract can be a “big” position. Look for contracts that suit your risk tolerance and trading plan. This helps you manage risk and learn from real market experiences before increasing your risk.

Step 7: Monitor, adapt and stay informed. Continuously track your trades, review your performance and adjust your strategy as needed. Futures markets can be volatile, so staying flexible and learning from each trade is important. Follow news and updates on the markets you’re trading, as futures prices are often influenced by current events, economic reports and global market conditions.

Step 8: Keep learning. The best traders continually seek knowledge and understanding. By following these steps and gaining experience, you can progressively become a skilled futures trader. The best traders learn something new each day.

The futures market plays a key role in the global economy, offering traders and investors opportunities to profit from price movements and manage risk. Each futures contract is standardised and allows you to buy or sell an asset at a set price on a future date. Most futures traders aren’t looking to take ownership of an underlying asset. Instead, they’re often looking to buy futures low and sell high or sell high and buy low. While futures can offer benefits like leverage, liquidity and nearly 24-hour trading, futures trading comes with risks such as the potential for large losses due to high leverage. To succeed as a futures trader, it’s important to educate yourself on how futures work, develop a solid trading plan, start small and continually monitor and adjust your strategy. Understanding the differences between futures and other assets, along with their associated risks and rewards, is essential for long-term success.

Important information

When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.

Futures are complex products with a high risk of losing money rapidly due to leverage. They’re not suitable for all investors. Before you invest, you should make sure you understand how futures work, what the risks are of trading futures and whether you can afford to lose more than your original investment. Please review the Futures Risk Disclosure Statement prior to engaging in futures trading.

Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.