Futures are one of the types of derivative financial instruments (derivatives), a futures contract that fixes the obligations of the parties to conclude a deal in the future on agreed terms. This definition may seem confusing to many retail investors and private traders. However, in fact there is nothing complicated here.
Let’s imagine a situation that a potential buyer would like to purchase a batch of 1000 units of goods. At the same time, he assumes that in six months, when he needs this product, its price will increase significantly. Therefore, he is interested in paying current prices. There is a seller on the market who is satisfied with the current price for this product. However, it still needs to be produced and a batch of the same 1000 units will be ready in just six months. These participants can enter into an agreement among themselves, under which the seller undertakes to supply and the buyer to pay for the goods, indicating in its terms:
- completion date – in six months;
- batch size – 1000 units;
- calculation at the price fixed at the time of conclusion of the contract.
In fact, such an agreement is a futures contract.
Thus, it becomes possible to explain what futures are on the exchange in simple words. These are contracts (agreements) under which the buyer and seller obliged after a certain period of time (that’s why it is called urgent) to make a transaction on the terms specified at the time of conclusion of the contract.
All that remains to be clarified is the concept of a derivative instrument. Here, in principle, there is nothing complicated either. The contract is concluded regarding some asset, for example, wheat, precious metals, energy resources, shares, etc. This asset is called the underlying asset. Accordingly, a futures is a trading (exchange) instrument produced, or rather, derived, from the underlying asset.
In trading on world markets, contracts with future execution are widely practiced. Such agreements are concluded among themselves, for example, by producers and consumers of goods such as wheat and other agricultural products, oil, gas, metals (i.e., commodity market assets). Futures, in comparison, have 2 main differences:
Forwards are settled “here and now”, at the time of conclusion of the contract, and delivery is made within the agreed time frame. Futures are settled and delivered at the time of execution (expiration) of the contract.
Forward contracts are concluded outside of an exchange, can have any characteristics and, as a rule, are one-time or renewable. A futures contract is an agreement with standardized parameters, concluded on an exchange that guarantees the fulfillment of obligations by the parties, and is repeatable (multiple).
Futures characteristics and specification
Futures is a standardized futures contract for which the following characteristics are established:
Performance (expiration) period is the duration of the contract. In the practice of exchange trading, weekly, monthly, quarterly, semi-annual and annual futures are used. In addition, there are so-called One-day (or “perpetual”) futures, which are valid for one trading day and are automatically extended the next. Such contracts are traded mainly on centralized cryptocurrency exchanges. In 2022, on the Moscow Exchange (for the first time in the world on a traditional exchange platform), 3 such contracts were put into circulation at the US dollar-Russian ruble, euro-ruble and yuan-ruble rates.
These and other characteristics are specified in a document called a contract specification and fully describe the exchange instrument. The specification includes the characteristics already described, as well as:
Contract name and codes. For example, the “perpetual” futures for the dollar ruble on the Moscow Exchange is called “One-day futures contract with auto-extension for the US dollar – Russian ruble exchange rate” and has the code USDRUB.
- Its type is delivery or settlement;
- The units in which quotations are presented, for example, gold futures are quoted in US dollars per troy ounce;
- Price step and its cost;
- Guarantee provision (GS).
Collateral is one of the features of exchange futures, which is associated with the settlement procedure. It is said above that settlement of futures contracts is made at the time of execution (expiration). Thus, at the time of concluding the contract, it is not necessary for the buyer to have the entire amount in the account to pay for it. Similarly, it is not necessary for the seller to have the entire volume of the underlying asset at the time of selling the futures.
But to guarantee the fulfillment of obligations, certain amounts or volumes of assets are reserved in their accounts, which cannot be involved in other transactions. They are called guarantees. As a rule, the GO is from 10 to 20% of the value of the underlying asset at the time of purchase/sale of the futures.
As a result, for a trader, futures trading is analogous to unsecured margin transactions. This ensures high profitability of futures trading, but at the same time significantly increases its risks.
Types of futures
As stated, the specification of futures contracts indicates their type. There are two of them:
Deliverable futures. It assumes that at the time of expiration the underlying asset is delivered from the seller to the buyer. For example, when one futures contract for Gazprom shares is concluded on the MICEX, upon execution, the seller transfers 100 shares (1 lot) to the buyer, and the buyer pays for them at the price fixed at the time of purchase of the futures. By the way, all stock futures on the Moscow Exchange are deliverable.
Settlement. In this case, the underlying asset is not delivered, and the buyer and seller pay for it in money. Those. if a gas futures was purchased, and the gas price has risen, at expiration the seller pays the buyer the difference in prices at the time of execution and purchase of the contract. The seller suffers a loss, the buyer makes a profit. If the price of gas has decreased, the buyer will pay the seller the difference in prices and will be at a loss. The seller will receive a positive financial result.
How to trade futures
Futures trading is not much different from transactions with other exchange assets. The trading participant must have a brokerage account with access to the derivatives market. In Russia, contracts are traded on the Moscow Exchange derivatives market (FORTS). Not all brokers provide access to it for private clients; the possibility of trading needs to be checked. In addition, some brokers require a separate account or sub-account for trading in the derivatives market. In this case, they will have to be opened. If a broker, such as Finam, allows trading contracts directly from a brokerage account, no additional action is required from the investor. The latter option is much more convenient, since it allows you to use any liquid assets accounted for in a brokerage account as GO.
After all preparatory operations, the trading participant can place orders to buy and sell futures. The main requirement is that there must be enough funds in the account to reserve the guarantee collateral. More detailed instructions, as well as futures trading options, are provided here.
The guarantee of fulfillment of obligations under futures contracts is the exchange. In most cases, it acts not so much as an intermediary, but rather as a central counterparty for such transactions. This means that the exchange guarantees each trading participant the conclusion of a transaction, acting as a buyer for the seller of the contract and a seller for its buyer. This also allows you not to wait for the contract to expire, but to make a reverse transaction at any time.
However, in futures trading, the liquidity indicator is of great importance. To reduce risks, it is recommended to trade only highly liquid contracts. For example, the most liquid futures on the Moscow Exchange for different types of underlying assets:
- for shares of Gazprom, Sberbank and VTB;
- on the RTS, Moscow Exchange and S&P 500 indices;
- for exchange rates – yuan-ruble and dollar-ruble;
- for commodity assets – natural gas, gold and Brent oil.
In general, futures are highly profitable instruments, trading on which is available to all private investors without restrictions. Due to the high risk, non-qualifiers will have to undergo testing to conclude the first deal. The contract trading technology itself is practically no different from operations with assets on the spot market.
