Many investors ask, how did futures trading get started?
For the U.S. futures markets, it all started in Chicago in 1849. Chicago was a major commercial center for agricultural products. Farmers (sellers) and agricultural dealers (buyers) began creating ‘contracts’ between each other to set prices for ‘future’ delivery.
For example, a wheat farmer would enter into an agreement to sell 5,000 bushels of his wheat to a flourmill at a specified price in 3 months. By doing so, the farmer knew in advance what he will be paid for his wheat and the flourmill knew exactly what its cost will be in 3 months to purchase the wheat. Neither party had to wonder what wheat prices might be in the future.
As this practice of creating these contracts for ‘future delivery’ developed between producer and user, these ‘futures contracts’ began to be bought and sold by third party investors for speculation purposes.These investors had no interest in delivering or taking delivery of the commodity, they simply were trying to profit as prices moved up and down during the life of the futures contract.
Jump forward 171 years to today and the Chicago Mercantile Exchange (CME Group) is now the world’s largest futures exchange. The CME provides ‘price discovery’ for both producers & end users (hedgers) and investors, personal & institutional (speculators).
For those investors looking to invest in commodity futures & options, an account with a licensed futures broker is required and will serve as your connection to the futures exchanges.
Similar to investing in stocks, commodity futures contracts are available on a wide variety of markets such as Gold, Crude Oil, Stock Indices, Sugar, Corn and Cattle. Futures investors, or traders, will choose a particular commodity they feel prices are either going up, or down, and will then enter an appropriate order with their futures broker. Today, the vast majority of futures traders place their orders through online trading platforms but there are still full-service brokerage firms that also offer their clients the ability to speak with a licensed futures broker to get assistance and advice with their trading.
From there, the mechanics of futures trading is quite straightforward; if the price of the futures contract purchased goes up, you profit – if prices go down, you incur a loss.
Let’s look at a specific futures trade example. Let’s say in January, an investor thinks the price of Crude Oil will be rising over the next couple of months. With this time frame, the investor chooses the March Crude Oil futures contract to trade. He/she purchases one (1) March Crude Oil futures contact at a price of $46.78. The NYMEX WTI Crude Oil futures contact is the most popular and liquid (no pun intended) Crude Oil futures contract in the world and is traded on the CME exchange. The trade symbol for this futures contract is: CL. Each Crude Oil futures contract represents 1,000 barrels of Oil. If we do some simple math, we can see the total value of this futures contract is $46,780.00 ($46.78/barrel x 1,000 barrels). However, futures traders only have to put up small portion of the contract value known as ‘futures margin’. Unlike margin in stock trading, which is a loan to purchase stock shares, futures margin is the amount of funds an investor must have available in their trading account to enter into a particular futures contract – think of futures margin as a performance bond. At the time of this writing, the futures margin requirement for Crude Oil (CL) is $4,510.00 per contract – less than 10% of the total value of one Crude Oil futures contract.
Once the investor has established his/her long Crude Oil position, he/she now hopes for prices to rise. Crude Oil futures contracts trade in 10¢ increments which is equal to $100 ($0.10 x 1,000 barrels). Let say prices rise 60¢ per barrel to $47.38. The investor would have an open profit of $600 ($0.60 x 1,000 barrels). At that point he/she could liquidate his/her position by selling it and realize a profit or, if he/she felt prices were going higher, continue to hold the position. Conversely, if Crude Oil prices dropped 60¢ after the investor established his/her position, then the investor would have a $600 loss.
Keep in mind, as these are ‘futures’ contracts, they have an expiration date – a date which the contract will expire and all positions must be liquidated, win, lose or draw.
Again, trading futures contracts is similar to trading stocks with the major exception being the leverage extended to futures traders through futures margins.
For those investors new to futures trading, we highly recommend working with a licensed futures broker who can assist you with the intricacies of trading futures & futures options.
Insignia Futures & Options is currently accepting new futures trading accounts. If you don’t already have your own Insignia Futures & Options trading account, I invite you to open yours today…
Principal Futures Broker
Series 3 & Series 30 Registered
Phone: 1-847-379-5000 ext. 101
Toll Free: 1-866-892-2030 ext. 101
Insignia Futures & Options, Inc.