Introduction to Futures Trading: Contracts, Leverage, and Major Markets

WELCOME to Infolib’s resource library!

This educational resource, pertaining to trading and investing, is a continual work in progress and intended for users who are interested in self-educating themselves, there are no fees or classes. For those interested in learning more about the website’s tools, the wiki will be more insightful. As a disclaimer, nothing here is financial advice, and the examples provided are incidental.

Table of Contents:

Introduction to Futures Trading
How do Futures Contract Function?
Advantages of Futures
Most Liquid Futures Contracts
Mini and Micro Futures
Agricultural Commodities
Metals
Energy
Currencies
Indices
Financials
In Closing

Introduction to Futures Trading

To cite Investopedia, “Futures are contracts to buy or sell a specific underlying asset at a future date”. Very simply put, in the stock market, you typically buy shares of a company, or options, which are rights to buying shares at a future date and set price, futures function similarly but with assets instead. If you were registered to trade through the Chicago Mercantile Exchange, for example, you could actually receive physical delivery of lean hogs, wheat, or thousands of ounces of silver. Futures developed as agreements between producers and manufacturers, but have evolved. Today, they are almost exclusively speculative tools and most traders get rid of their paper contracts before they are due for delivery. Most exchanges don’t even bother allowing you to accept deliveries and you’d have to go out of your way for one that does. Futures contracts have a few distinct advantages and differences, which will be discussed throughout this article. There are a ton of different markets to choose from, many of which you can only access through the futures market.

https://www.barchart.com/futures

The above site provides a comprehensive list of markets you can engage with, the most significant categories being agricultural (cattle, hogs, coffee, cocoa, soy, etc.) metals (gold, silver, platinum, etc.) energy (oil, coal, natural gas, etc,) currencies (a vast array of international currencies adding recently BTC, ETH, and XRP) indices (S&P 500, NASDAQ, etc.) and financial futures (Fed funds, bonds, T-notes, etc.). Each of these will be covered.

How do Futures Contract Function?

All futures contracts are inherently leveraged; the amount you pay to enter your futures contract is not indicative of the value of the underlying asset. Standard gold futures contracts, for example, represent 100 troy ounces of gold, with gold (as of this writing) at $4500, this means the underlying is worth $450,000. There are smaller futures contracts as well, but even then, you are not expected to put up the full amount. Instead, you are only expected to put up about 5% of this amount, so around $22,500. This is known as the initial margin. How futures work is largely dependent on each contract, but say in this case that a $1 move in either direction for the price of gold equals to a $100 gain or loss for your account, this gives you a good idea of how much profit or loss you can expect. There is a catch, however. Leverage allows you to utilize a small amount of capital for greater gain, but this is counter balanced by margin maintenance. This amount is calculated against your initial margin and the free cash (unused money) you have in your futures account. A sharp move against your price can see you being issued a margin call, which requires you to contribute more funds to your position to maintain it. In a particularly sharp move against you, you will be outright liquidated, often losing substantial portions of your contract, but you are not allowed to go into the negatives.

As always, you make money when you are right, you lose money when you are wrong.

Advantages of Futures

There are a few distinct advantages to the futures market. Their leveraged nature allows considerable gains, they don’t have to worry about the funky math behind options, and certain futures operate 24/7. The main risk comes with margin and leverage, if the trade consistently goes against you, you will be punished. Read about Nick Leeson, a trader that bankrupted Barrings, one time the oldest merchant banks in the world. Probably the single biggest advantage of futures trading, at least for Americans, is their considerable tax advantages. They are not treated purely as short term capital gains, which are taxed at a significantly higher rate than long term capital gains. Read into the 60/40 split if you want to learn more, but for active day traders, this rule alone is enough to push people into the futures market. You can save thousands of dollars in taxes, but you can’t trade everything you can in traditional markets, like options or specific stocks.

Exchanges

Most major exchanges allow for futures, you just have to apply for them separately. Special mention goes to WeBull, which has a very painless registration process and easy access to futures.

Most Liquid Futures Contracts

Not all futures contracts are created equal, and many of the smaller ones have liquidity issues, preventing you from selling for the price you want, when you want. Even if your heart is set on becoming rich by trading cheese futures, the lack of liquidity in this market may dash your dreams. A good place to start would be in the most liquid futures and choosing your favorite of the litter. To that end, here is a list of the most liquid contracts.

Moving forward, different commodities will be covered, but some of the ones already discussed in the Commodities article will be included here for convenience as well.

Mini and Micro Futures

“Mini and Micro Futures contracts enable traders to trade futures with less margin than their full sized equivalents. To trade the full sized E-Mini S&P you would need over $10,000 per contract, but the Micro S&P margin is 1/10th the amount. Smaller sized contracts, which are available across asset classes, often have lower fees (both exchange and brokerage) than larger sized contracts.” – Barcharts

These smaller sized contracts let small fry participate in the futures market without betting the equivalent of a down payment on a home. Plenty of markets are reflected here, but not all.

https://www.barchart.com/futures/micro-contracts

Agricultural Commodities

For simplicity, Livestock, “Softs”, and Grains have all been included into this section. Many of these commodities influence each other (the cost of grain and corn affects how much money it takes to grow a cow) but the softs are the most unique of the bunch.

Livestock: Cattle, Pork, Milk, Whey, and even Butter and Cheese.

Grains: Corn, Soybean, Wheat, Oats, Rice, Canola

Softs: Cotton, Coffee, Sugar, Cocoa, Sugar, Lumber, Orange Juice

There is a ton of nuance to these assets that cannot be adequately covered, but weather, harvests, costs of inputs, and many other things influence the value of these items. Lumber, for example, is largely correlated to the housing and building market. Cocoa is known to be one of the most volatile, as its growing is concentrated in parts of the world that are regularly influenced by adverse weather and natural disasters. Anyone whose seen the price of meat at grocery stores also knows that this stuff has been flying.

https://www.barchart.com/futures/meats

https://www.barchart.com/futures/grains

https://www.barchart.com/futures/softs

Metals

Metals: Gold, Silver, Copper, Platinum, Palladium, Aluminum, Steel, Uranium, Lithium

Gold, in terms of size, is the oil of metals. Gold has plenty of industrial uses, ranging from electronics, aerospace, medicine and jewelry. About half of the gold mined every year becomes jewelry and the status associated with gold has continued for thousands of years. Gold bullion is also popular among those seeking to protect themselves from the fluctuations of global crises and inflation, as it has managed to retain its value well over the course of centuries.

Silver is the most conductive metal on earth and as such has seen huge interest from the industrial sector. Electronics, medicine, chemical production, a recent boom in solar panels, and is even needed in nuclear power plants. To a lesser extent than gold, jewelry as well. Similarly to gold, silver bullion is also seen as a hedge against inflation and, thanks to being substantially cheaper than gold, it is much more accessible to the average person.

Copper is a fairly abundant mineral, one of the best conductors of electricity, and an underappreciated cornerstone of modern technology. It’s application in electrical wiring is nearly universal, leading to copper’s use in electronics, renewable energy systems, transportation and a variety of adjacent industries. Even in construction and plumbing, copper is a regularly used material. Its probably one of the most flexible metals on the market, and if it weren’t for its availability, it would be one of the most sought after minerals out there.

Platinum is one of the rarest critical metals on earth and has a very limited geographical distribution. Platinum is mostly used in catalytic converters for the automobile industry, but also electronics, medicine, and jewelry. The rarity of the metal has seen it become an investment on its own and between 1972-2008, it traded higher than gold.

Palladium, like platinum, is a member of the platinum metals group and is also a rare mineral. Palladium’s primary use is in catalytic converters. It also used as a catalyst in alloys, electronics, medicine and recently in fuel cell technology. Russia controls a significant portion of palladium production, so market access to it is fairly limited.

Aluminum is similar to copper, extremely abundant and also extremely useful, found across many different industries ranging from construction, aerospace, automotive, and even recent applications in electronics thanks to the “aluminum sputtering target”. It is the 3rd most abundant element on earth, but is rarely found pure, so it is almost always found as a result of the refining process.

Steel is also important, used in almost every type of engineering and construction, home goods, transportation, and a ton of other uses. It’s so prevalent, that it’s hard to isolate one market that strongly correlates to it, other than booms in consumption and manufacturing.

Uranium has recently seen renewed interest thanks to a huge increase in demand in electricity for powering data centers and developing AI projects. It has a simple use case, primarily in nuclear power plants to generate tons of relatively clean electricity. So long as demand for power continues to grow and power plant meltdowns don’t scare people away again, its a fairly well positioned mineral. Keep in mind that it takes years for nuclear power plants to become operational.

Lithium is almost exclusively used as a battery metal and considering the recent boom in electric vehicles and other advances in battery usage, has performed well recently. There have been recent contenders competing with lithium, solid state batteries of the sodium-ion nature for example, so it is hard to say what the future holds in store for it.

https://www.barchart.com/futures/metals

Energy

Energies: Crude Oil, Natural Gas, Ethanol

Oil, by far the largest and most traded commodity, is the black gold of the world economy. There are endless amounts of applications for oil; making transportation and distribution possible, petrochemicals, fertilizers, heating, plastics, the list really is endless. If you still aren’t convinced that oil is the most essential commodity, consider that without it, tractors would not work the fields, seeds would not grow without fertilizers, plastics would not keep the food shelf stable, trucks would not deliver the food to stores, and you would not be able to drive and pick up your groceries. Add the myriad of other uses for oil and you’ll see there’s a reason wars have been fought for it. That said, oil is controlled by a select few nations fortunate enough to have access to it and governments without direct access typically conspire to keep the price of oil low. Cheap energy is generally correlated with good economic times and the opposite is also true; the Energy Crisis of the 1980s and the Great Recession of 2008 both featured periods of increased energy costs that thwarted economic recovery. Oil is traded in multiple different forms, be it crude or as gasoline.

The Natural Gas market is smaller than oil, but NG is essential to the world. The most common uses for it are heating, cooking, electrical generation (43% of the US power grid was supplied by it in 2023) and recently attempts to use it as a fuel. Due to it not being the basic building block of civilization like oil is, it doesn’t see the same amount of attention, but there is certainly a market for it.

Ethanol is by far the smallest energy fuel market. Originally schemed as a renewable resource fuel, which largely used corn and a ton of non-renewable energy sources to produce, it has become largely dependent on government subsidies to exist and many companies engaged in it have since closed their doors. E-85 cars were about the closest consistent user of ethanol, but not many are still being made and until we see some sort of improvement in efficiency, this fuel is likely to remain languishing.

https://www.barchart.com/futures/energies

Currencies

One of the premier uses of futures is the currency market, where traders can speculate the value of the dollar against international currencies. Only the major currency pairs are commonly traded on most exchanges, and you’d have to shop around in order to find pairs that are not listed below.

USD vs. Euro, Australian Dollar, British Pound, Canadian Dollar, Japanese Yen, Swiss France, Mexican Peso, New Zealand Dollar, Brazilian Real, and South African Rand.

Recently introduced were crypto currency pairs as well, giving traders access to Bitcoin, Ethereum, Solana and XRP (the later two only available in micro form)

It’s difficult to gauge how exactly one country’s currency performs against another, but economic policy, international news, manufacturing and banking reports, and other events contribute to fluctuations in price between different currencies. This sector is a beast of its own, and most people who engage in it usually only speculate in one or two currencies that they actually understand.

https://www.barchart.com/futures/currencies

Indices

Here, traders have access to indices based on the American stock market, though exchanges might include an index like the Japanese Nikkei. The S&P 500 is dedicated to the top 500 companies on the stock market, the NASDAQ 100 are the top tech companies, Russell 2000 is focused on “midcap” stocks with smaller market influence. The DOW tracks the 30 top companies on the market

https://www.barchart.com/futures/indices

Financials

This sector is probably the most complicated of the bunch and should only be undertaken by those with a keen understanding of how money works, how it is moved, and how federal monetary decisions impact the price of these contracts. In the interest of not misinforming anyone, the only advice here is to really do your research. The following contracts can be traded in this sector: 30-Year T-Bond, Ultra T-Bond, 10-Year T-Note, 5-Year T-Note, 2-Year T Note, 30-Day Fed Funds, 3-Month SOFR.

https://www.barchart.com/futures/financials

In Closing

Futures have a couple distinct advantages over traditional markets, but to be clear, they are designed for traders, not investors. Those who don’t keep positions open for over a year should strongly consider looking into them. There are plenty of traders who dislike the math and functioning of options, and prefer a simple approach. There are no time decay functions, or other underlying mechanisms here, you either buy the chart at the right moment or you lose money doing so. For those who work strange hours of the night, the ability to access these markets night or day is another boon, though trading volume is usually correlated to the opening and closing of the stock market.