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In commodity markets, futures contracts represent legally binding agreements between two counterparties to buy or sell a specific amount of a commodity at a set price on a particular future date. They focus on the future delivery of an asset, as opposed to spot trading, where the transaction happens instantly.
Futures contracts offer a way for speculators to profit from price fluctuations in the underlying commodity and for hedgers to help protect themselves against unfavourable price movements. You will often find that derivatives are generally referred to as ‘price guarantees’.
Unlike forward contracts, futures contracts are standardised and traded on futures exchanges. CME Group’s Chicago Board of Trade (CBOT), for example, specialises in agricultural commodity futures like corn, wheat, and soybean futures. However, futures exist for many underlying assets, not just commodities. For instance, futures contracts are available on equities (e.g. S&P 500 futures), currencies, and even interest rates.
Given this standardisation, futures contracts include vital details that are essential to understand before trading. Today, we’ll break down the critical components of a futures contract and how to read them, giving you the confidence to begin navigating this specialised market.
Of all the components in a commodity futures contract, the following lays the groundwork for grasping the more complex attributes.
The underlying asset represents the commodity that the futures contract is based on. This could be agricultural commodities (like corn or soybeans), metals (like gold or silver), or energy products (like crude oil or natural gas).
The contract size is the amount of the commodity represented by a single futures contract. For instance, a WTI crude oil contract on the New York Mercantile Exchange (NYMEX) signifies 1,000 barrels; a soybean contract on CBOT is 5,000 bushels.
The expiration date is a set date on which the contract ceases to be valid. After this date, the contract is either settled in cash (collecting the difference between the agreed price and the market price [spot price]) or through physical delivery, depending on the contract terms.
The delivery month is the month that the contract holder must take delivery of the commodity or settle in cash. Note that the expiration date will always fall within the delivery month.
The tick size is the minimum price movement allowed in futures trading. For instance, if a gold futures contract is $0.10, its price moves in increments of $0.10.
Related to tick size, the tick value represents the monetary value gained or lost with each tick movement. To calculate this value, multiply the contract size by the tick size. If a gold contract represents 100 troy ounces and has a tick size of $0.10, the tick value would be $10.
The limit on how much a futures’ price can move in a single day is referred to as the ‘price limit’. These price limits vary between different assets and commodity exchanges and are intended to curb excessive volatility. Trading is stopped for the day or temporarily halted once these limits are reached.
Trading symbols in commodity futures markets differ from the tickers many traders are used to. They typically comprise three parts: a root symbol, contract month, and year.
Let’s use CLN24 as an example. CL is WTI crude oil’s symbol; N indicates it expires in July; 24 means we’re looking at a contract for July 2024.
Understanding futures prices and quotes is fundamental. Here are the most common data points to know:
Lastly, the contract specifications.
These detail the nitty-gritty of the contract and can have unintended impacts on trading strategies and risk management if not properly understood.
While specifications vary from one physical commodity to another, they can always be found on the exchange’s website.
An exchange is where the futures contract is listed and traded. Different exchanges specialise in different commodities—NYMEX is the primary exchange for energy futures, while the Commodity Exchange Inc. (COMEX) is renowned for its precious metals contracts.
The trading hours are the hours the contract is traded in. Commodities have varying opening and closing times and may be listed in the exchange’s local time, so it’s essential to check before trading.
Margin requirements are the funds that are required in a trading account to open and hold a futures position. Failure to meet maintenance requirements could result in a margin call, forcing the trader to either deposit more money or close out positions.
The quality criteria the underlying commodity must meet, allowing traders to know exactly what’s being bought and sold. For instance, WTI crude oil must meet specific sulfur, gravity, and viscosity requirements.
The settlement method details how the contract will be settled at expiration, either through physical delivery or cash settlement.
The delivery procedure details steps required for physical delivery, if applicable, typically including notice periods and logistics.
Futures contracts can seem daunting at first glance; after all, many unique aspects go into these instruments. However, by familiarising yourself with the components, you’ll be well on your way to a fruitful futures trading journey.
With FP Markets, you can also trade Futures CFDs. Unlike futures contracts that are exchange traded, futures CFDs are traded over the counter (OTC) and are always cash settled.
Futures CFDs are also available on both MetaTrader 4 (MT4) and MetaTrader 5 (MT5). For more information on the benefits of trading futures CFDs with FP Markets, consider visiting our in-depth explainer page.
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