Futures products come in all shapes and sizes, facing a broad spectrum of asset classes. However, no matter which futures contract you’re interested in―whether it’s crude oil or corn―it exists as a standardized, exchange-traded financial instrument.
Standardization provides traders with functionally consistent trade execution. All contracts are based on an underlying asset and have an expiration date and defined leverage. Because of these three essential specifications, traders are able to trade almost anything.
The Underlying Asset
A futures contract is a financial derivative product. As a derivative, its aggregate value is based on a specific quantity of an underlying asset. For instance, corn futures (ZC) are based on the value of 5,000 bushels of #2 yellow corn (and other grades at defined premiums).
Each contract listed on an exchange is grouped according to asset class. Here are the largest classifications:
- Equities indices
- Financials
- Agricultural
- Currencies
- Energies
- Metals
One of the primary benefits of trading futures is the diversity of offerings. Market participants are able to gain exposure to almost any asset class for hedging or speculative purposes.
Expiration
Futures products are perishable investment vehicles that have a finite shelf life. Because all contracts are subject to a concrete expiration date, they may not be held in perpetuity. This attribute makes trading futures a bit more involved than simply buying and holding a stock, mutual fund, or ETF. Upon expiry, the futures contract is settled and is no longer tradable.
If you’re going to trade futures, it is important to be aware of your product’s expiration date. You can easily find it in the contract specifications, alongside settlement procedures. As an example, assume that Oba the oil trader is long one lot of March 2020 WTI crude oil. To avoid a surprise liability, Oba refers to the WTI contract specs for details on expiration and settlement:
- Expiration: Per the CME, “trading terminates 3 business days prior to the 25th calendar day of the month prior to the contract month. If the 25th calendar day is not a business day, trading terminates 4 business days prior.”
- Settlement Procedure: Deliverable
In Oba’s case, trading will terminate for the March 2020 WTI futures contract on Friday, February 21, 2020. In the event Oba hasn’t closed out the open position by day’s end on Feb. 21, delivery for 1,000 barrels of WTI crude oil will be assumed and payment required. Unless Oba is a large-scale consumer, the liability could be staggering.
Leverage
For many individuals, the availability of financial leverage makes the futures markets attractive environments. Futures are traded on margin, meaning that only a fraction of each contract’s value must be deposited in order to trade. This is a far cry from the stock market, where margin requirements are vastly higher.
A futures contract’s leverage is a function of its size, which is determined by the amount of the underlying asset defined in the contract specs. As mentioned above, the quantity of full-sized CME corn futures is 5,000 bushels per contract. Subsequently, corn is traded with a minimum price fluctuation of one-quarter of one cent per bushel, a per-tick value of $12.50. So, if the price of corn moves by one cent per bushel, corn futures move by a positive or negative $50.
As a general rule, contracts with larger quantities are more expensive to trade. Fortunately for active traders, it is fairly simple to increase or decrease exposure; all you need to do is find an appropriately sized futures contract. For instance, if you’re a small retail corn trader, the CME’s full-sized issue may be too rich for your blood. Trading mini corn futures (XC) offers a smaller contract size (1,000 bushels), reduced tick value ($1.25), and one-fifth of the required margin.
Getting Started with Futures Contract Specifications
When it comes to active futures trading, securing a good education is a key to success. One area best not ignored is contract specifications. Though it’s not necessary to memorize the specs of every product on the board, knowing the specs for the products that you trade is an integral part of being a competent trader.
To learn more about the futures markets, feel free to check out the online educational portal at Daniels Trading. Featuring a comprehensive look at market basics as well as more advanced concepts, it’s a one-stop shop for all things futures.
