Home > About Us > What are Futures & Options
Futures contracts are legally binding agreements, made on the trading floor of a futures exchange, to buy or sell a commodity like oil, coffee, or gold, or a financial instrument like a currency or a treasury bond, sometime in the future. Futures contracts are standardized according to the quality, quantity and delivery time and location for each commodity. The only variable is price, which fluctuates on an exchange's trading floor.
Options are contracts that give the buyer the right, but not the obligation, to buy or sell a particular item at a certain price for a limited time. Only the seller of the option is obligated to perform. Options contracts can be based on a company's stock, a particular commodity like oil, gold, etc., or a financial instrument like a currency or a treasury bond. The price or "premium" of an option is dictated by multiple factors, including, but not limited to, the time to expiration and the underlying futures contract value. Option purchases differ from futures contracts in that the risk is limited to the investment made and no additional margin is needed to maintain a position.
The primary economic purpose of futures markets is for users or producers of commodities and financial instruments to hedge or transfer price risk. A user of commodities would want to buy or "go long" a futures contract to lock in a low buying price, whereas the producer of a commodity would want to sell or "go short" a futures contract to lock in a high selling price. In doing so, both buyer and seller are considered properly hedged against dramatic price fluctuations.
However, the great majority of volume on futures exchanges comes from speculators or investors who seek to profit from anticipated price movements and take advantage of supply and demand trends. Speculators are invaluable because they assume market price risk and add liquidity and capital, while making the futures markets more efficient.
Since an investor is required to deposit margin on a futures contract (as little as 2% on the full value of a deliverable contract) there is tremendous leverage, which means small moves can result in big profits or losses. This leverage can provide investors with tools to hedge or mitigate risk in a portfolio. It can also provide the potential for investors and speculators to realize formidable gains. However, if misused, leverage can result in devastating losses as well. For a list of tradable futures contracts, please see our Contract Specifications in the Education section and the Current Margin requirements in the Tools section.
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