Futures Contracts Trading Exchange Guide

A futures contract is an exchange traded derivative which binds the holder with an ‘obligation’ to buy or sell, as opposed to an options contract, which gives the older the right to exercise the contract, or option, but not an obligation. A futures contract must be completed on or before the agreed upon settlement date. This is accomplished by one of the following means:

• The seller delivering the commodity to the buyer
• Cash being transferred from the trader who suffered the loss to the one who made a profit.
• The holder selling a long position or buying into a short position.

A margin, usually about 5-10% of the contract value, is required to be deposited with the futures exchange, by both buyer and seller. First time futures traders will have to fill up an application which includes information about your trading experience, assets, employment details and other personal data. On your application is approved, you can start trading futures.

It may be best for a new trader to start with the S&P 500 E-mini contract, which allows new traders to speculate on stock indices using modest capital to leverage and magnify gains, and losses. An E-mini costs around $4000 to start with, as compared to a standard futures contract, which ranges around $20,000. The appeal of an E-mini on the S&P 500 lies in the low commissions associated with electronic transactions ( around $5 ), the magnified gains and low margins. Most day traders prefer to invest in a futures contract based on data which predicts a small up tick, and divest positions immediately, rather than hold on to it overnight, since the index could be affected by global or national events.

It is important for new traders to remember to keep commitments, or margins, within available capital, and limit trade to one contract at a time. While gains can be lucrative, a shift in the index could wipe out gains across multiple positions and force the trader to pay more than the available margin. Thus, while you are learning the ropes, a limit on the number of parallel contracts, a margin amount which is less than half your available capital and contracts based only on the stock indices are recommended. This ensures a net gain, limited losses and lack of exposure to risk from swings in specific stocks or sectors.

Please note that while futures trading has many advantages compared to stocks and options, data availability for futures contracts is also costlier and new investors are easily lured into high stakes games with considerable risk due to the easy and low cost entry levels and procedure. You are advised to consult your broker or financial planner to understand the implications and possible risks associated with futures contracts trading.