Financial Markets: Futures

The futures market is the oldest of all the financial markets dating back to the year 1710 with the establishment of the Dojima Rice Exchange in Japan. Instead of shares like in stocks, the unit of measurement in the futures market is referred to as a contract. This name is derived from the original purpose of futures markets which was to establish agreements between buyers and sellers of rice in Japan. Essentially, a futures contract allows a buyer and a seller of a physical good to agree to purchase a commodity at a specific price in the future. This is highly useful today in the agricultural sector. Producers of crops purchase futures contracts from buyers of their crops in advance of the harvest so as to hedge against any possible movements in the value of the crop. For instance, if a farmer buys 100 corn futures contracts at an underlying price of $400 that is set to expire after the crop has been collected, he or she has guaranteed the price and quantity of crop to be sold at a later date. If for instance, the value of a bushel of corn drops too $350 in the span of time between planting and harvest, once the crop has been harvested, the buyer of the farmer’s 100 contracts is legally obligated to pay the farmer $400 per bushel. As you can see, a futures contract is a zero-sum game where there must always be a winner and loser. If the price of corn drops to $350 then the farmer makes a net gain off buying the futures contract, but the buyer takes a hit by being required to pay $400 for bushel. If the roles were reversed, and corn goes to $450 per bushel, the farmer now loses $50 per bushel in revenue and the buyer saves $50 per bushel. However, retail traders are not concerned with physical delivery of a good or commodity, rather they are simply concerned with predicting the movement of the underlying price. Capital can be gained from a futures contract by purchasing 100 contracts when corn is $400 per bushel and later selling it when corn moves to $450 per bushel. The net gain here is $50 times 100 contracts or $5000. Much like Forex, futures can also be traded on margin. Major exchanges such as the Chicago Mercantile Exchange (CME) specify that for every cent that the underlying Price of corn moves the retail trader can gain or lose $10. In our above stated example, the retail trader would stand to make 5,000 cents x $10 per cent x 100 contracts or $5,000,000. As you can imagine, making a trade of this size requires a very large account and most futures traders can make a full time income trading only between one and five contracts. There are futures contracts available for nearly every good imaginable such as: crude oil, gasoline, natural gas, corn, wheat, random length lumber, lean cattle, cocoa, and orange juice. Recently, the advent of the E-Mini Index Future contracts such as the /ES, /YM, NQ, and /TF, allow retail traders to directly trade the underlying value of the four major indices, which previously has not been possible. Futures are an excellent instrument for the sophisticated investor but are also useful to the beginning investor as they require a fairly small initial investment to begin trading ($10,000 as a low but safe value). 

CFTC Required Rule 4.41:

Hypothetical or simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been executed, the results may have under-or-over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profit or losses similar to those shown.

Hypothetical Performance Disclaimer: 

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.