Futures trading is the practice of buying and selling futures contracts, either to hedge risk as a commercial producer or consumer of actual commodities, or to seek investment gains as a speculator/investor.
Obligations when trading futures
When you enter into a futures or option contract through an individual account, you are required to make a payment referred to as a "margin payment" or "performance bond." This payment is small relative to the value of your market position, providing you with the ability to "leverage" your funds. Because trading commodity futures and option contracts is leveraged, small changes in price, which occur frequently, can result in large gains or losses in a short period of time.
Each day, your broker will calculate the current value of futures and option contracts held in your futures account. If the equity in your account has dropped in value to the "maintenance margin level" (approximately 75 percent of the amount required to enter into the trades originally), you must deposit more margin money to bring the margin up to the initial margin level (this is called a "margin call"). This eliminates the need to make repeated margin calls when daily price changes are relatively small.
If you don't meet a margin call within a reasonable period of time, which could be as little as one hour, your brokerage firm may close out your positions to reduce your margin deficiency. If your position was liquidated at a loss, you would continue to be liable for that loss. You can, therefore, lose substantially more than your original margin deposit.
If you are trading in a commodity pool, you have purchased a share or interest in the pool, and it is the pool itself that must make the performance bond payments and margin calls described above. Your contractual obligations as a participant in the pool, including your liability for any losses to the pool, must be described in the pool's disclosure document.
Development of Modern Futures Trading
Hedgers are those who are using futures to lessen price risk in a "commodity" they either own or wish to own in the future. Hedgers take a position in a futures market opposite to a position held in the cash market to minimize the risk of financial loss from an adverse price change. Or a hedger can buy or sell futures as a temporary substitute for a cash transaction that will occur later. One can hedge either a long cash market position (e.g., one owns the cash commodity) or a short cash market position (e.g., one plans on buying the cash commodity in the future). Hedgers are broad in nature. Agricultural producers and those using agricultural products to produce end products, those in the financial arena and corporations with currency and equity and index risk, oil producers and users, users of precious and industrial metals, and more, all can use hedging to offset their price risk.
Speculators are individuals who trade with the objective of achieving profits through the successful anticipation of price movements. Speculators come in many forms, from those who trade daily (day traders), swing traders who trade at longer intervals over a day or multiple days and weeks, and position traders who hold a futures position for potentially longer periods to take advantage of trends, and more.
Floor Brokers are persons with exchange trading privileges who, in any pit, ring, post, or other place provided by an exchange for the meeting of persons similarly engaged, executes for another person any orders for the purchase or sale of any commodity for future delivery. As trading has become increasingly electronic, floor brokers are a much smaller population than they once were.
Floor Traders are persons with exchange trading privileges who executes their own trades by being personally present in the pit or ring for futures trading. They are also called "locals." Like floor brokers, floor traders have lessen in number with the impact of electronic trading.
Structure of a Futures Trade
Leverage and Risk
- [http://www.cftc.gov/educationcenter/understandcontractobligations.html "Understand Commodity Futures and Option Contracts and Your Contractual Obligations ”]. CFTC.