Pete takes a step back from the diving board and explains the futures fundamentals every trader needs to know before they make their own splash.
Futures Contract Definition
A standardized agreement (meaning futures contracts are fungible - the goods are able to be replaced by an identical item) between two parties to buy or sell a product at an agreed price on a future date.
Just like stocks, in the futures market, the buyers of the futures contract expects price to increase and the seller of the contract expects the price to decrease.
Futures Margin Compared To Stocks & ETFs
If you purchase stock on margin, it acts as a partial down payment for the purchase of the underlying asset. Futures margin is money placed on deposit to guarantee each participant has the ability to perform in terms of the contracts and withstand the average daily price fluctuation of the underlying assets (it's sometimes called ‘good faith money’).
Futures have two types of margin:
- Initial margin: the amount of money that is required per contract to initiate a futures position required both by the buyer and the seller
- Maintenance margin: the minimum balance that must be maintained while holding a position or multiple positions - if the balance falls below this level, you will receive a margin call (the broker will ask you to put more money in your account) or the position will be liquidated.
At the end of each trading day, your account will be marked to market. This basically means that the profit or loss for a position will be cash settled at the end of each trading day.
Check out the video for an example of how mark to market works and affects your margin.
Futures Basics FAQs
Q: How many contracts result in the physical delivery (i.e. how often does someone have to figure out what to do with 5,000 bushels of wheat)?
A: Less than 2% of all contracts result in physical delivery. The rest are rolled or flattened out.
Q: Do futures contracts replace cash contracts?
A: No they do not. A cash contract is an agreement between 2 parties with specific terms, futures are a standardized contract.
Q: What is the only variable component of a futures contract?
A: Price. Thats the only thing that changes. Everything else is standardized.
Q: Is there only one contract size available?
A: No.
Strategies: N/A
Products Discussed In This Episode: N/A
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.