What are Futures?

Oil Futures

Anyone who is interested in the stock market has certainly come across the term futures. I would like to explain what futures are in this article.

What are futures?

As the name suggests, futures are financial products that are redeemed in the future. Let’s say you have a company that refines petroleum to make gasoline. To constantly produce gasoline, your company needs oil. You know today how much oil you will need in about 6 months. Assuming that oil is cheap at the moment, you could buy enough oil for the next 6 months now and save a lot of money. The problem is that storing oil costs money and you don’t have the capacity to store oil for that long. So your company buys oil futures, hoping to save money. Suppose you buy oil futures that expire in 6 months for $50,000. The price of oil is always quoted in barrels and a CL future (Crude Oil) contains 1,000 barrels.
Now the oil price rises to $100 in the next 6 months and you redeem your futures on the expiration date. You now receive 1000 barrels of oil per future, no matter what the oil price is at the moment. Since you bought the futures 6 months ago at the half price, you have saved $50,000 per future. However, if the price of oil had dropped to $25, you would have lost 25%.

For how long have futures existed?

Grain futures were traded in Amsterdam as early as 1556.

Who trades futures?

As you can see from the example with crude oil, it makes perfect sense to trade futures contracts as a producer, but also as a buyer. Banks, brokers, large investors, small investors, day traders, etc. also take advantage of the price fluctuations. Nowadays, anyone can open an account with a futures broker.

On what there are futures?

Agriculture: Corn, wheat, soybeans, coffee, live cattle, lean pork, milk, low fat milk, timber, etc.
Energy: Crude oil, gasoline, natural gas, etc.
Equities Index: S&P 500, Nasdaq, Russell 2000, Russell 1000, DAX, Nikkei, etc.
Forex: Euro, Yen, British Pound, US Dollar, Australian Dollar uvm.
Interest: 2-Year T-Note, 5-Year T-Note, 10-Year T-Note, US Treaury Bond, Eurodollar, uvm.
Metals: Gold, Silver, Platinum, Copper, Aluminum, Iron, and many more.

The largest futures exchange in the world is the Chicago Mercantile Exchange. If you want to trade futures, you should look for a broker that offers CME Group products. At the Frankfurt Stock Exchange, trading in futures contracts is so low that it really makes no sense to trade futures there.

Trading in futures involves extremely high risks

Anyone trading futures should really know what they are doing. Otherwise, losses worth millions can occur, even if you only trade with a small account.
Most traders, of course, do not intend to redeem their futures on expiration day. Who needs 1000 barrels of oil?
On April 20, 2020, crude oil futures plummeted, with catastrophic consequences for trader Syed Shah from Canada. What had happened? The world was in a global lockdown due to the Corona crisis. All over the world, people stayed at home, which meant that significantly less oil than usual was taken. All oil storage facilities were full and nobody knew what to do with the oil. Everyone tried to sell their futures before the expiration date, but there were no buyers. The May 2020 CL Future fell and fell until the Canadian saw a price of $0.01 on his screen. He bought more and thought to himself, wow I’m going to get rich overnight because I’ll never get 1000 barrels of oil for $10 again. In total, he had bought 212 futures that day. However, the problem was that the price dropped to -$3.70 that day, so into negative territory. The next day he received a message from his broker that he owed him $9 million. Ouch !!!
Shah had been lucky again in the end, because the mistake was due to a software bug. He should have seen the correct price and so his broker had to pay the damages.

Futures are usually traded with high leverage and that is simply not always very safe.

Leave a Reply

Your email address will not be published.