What is Futures Trading?

Futures trading, unlike spot trading, involves standardized tradable contracts based on certain commodities such as cotton, soybeans, oil, as well as financial assets such as stocks and bonds. The underlying asset of futures can be a commodity (e.g., gold, crude oil, agricultural products) or financial instruments.

Futures have a delivery period, which can be set for one week, one month, three months, or even one year in the future.

Initially, futures were used by farmers to hedge against the adverse effects of weather fluctuations on commodity prices. For example, when the weather is favorable, crops such as corn are abundant, resulting in increased labor input but decreased overall income due to oversupply in the market. Farmers came up with futures contracts to mitigate this risk. They would agree to sell a predetermined quantity of corn to a buyer at a specified price in the future. The buyer could then use this contract to purchase corn at a later date.

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What are the classifications of futures?

Futures can be broadly classified into commodity futures and financial futures. Commodity futures include agricultural products, metal futures, energy futures, and other commodities. Financial futures include stock index futures, interest rate futures, foreign exchange futures, and more. Within these categories, we can further divide futures into the following:

1. Commodity Futures

Agricultural: This includes futures based on agricultural crops, livestock, and other spot-traded commodities. Agricultural product futures have a long historical background because they originated from the need to trade agricultural products. Typical examples of agricultural product futures are soybeans, wheat, corn, cotton, rubber, as well as lean hogs, live cattle, beef, and other animal-related futures. Metals: these can be broadly categorized into precious metals and industrial metals.

• Precious Metal: This includes gold, silver, platinum, palladium, etc. Gold is widely used as jewelry and currency. In addition, silver and other precious metals with industrial applications, such as palladium and platinum, also have related futures contracts.
• Industrial Metal: In addition to copper, which is the most common, there are futures contracts for aluminum, zinc, lead, nickel, tin, etc.

Energy: These futures are based on energy commodities such as oilseeds and natural gas. Energy futures are perhaps more familiar in the commodity futures category because fluctuations in the prices of Brent crude oil and West Texas Intermediate (WTI) crude oil, which are often mentioned in the market, can affect retail gasoline prices. Therefore, even if individuals are not directly trading energy futures, they may still be interested in monitoring their price movements. Crude oil futures, particularly Brent crude oil futures and light crude oil futures, are popular. Apart from crude oil futures, energy futures also include heating oil futures, unleaded gasoline futures, diesel futures, natural gas futures, etc.

2. Financial Futures

Stocks: These futures are based on stock indices such as the Dow Jones Industrial Average, FTSE 100, DAX, Nikkei 225, Hang Seng Index, CSI 300, etc. Interest Rates: These futures contracts are based on security bonds and are used to hedge against the price fluctuations caused by changes in interest rates. Interest rate futures have various types and classification methods. Typically, interest rate futures can be categorized into short-term, medium-term, and long-term futures based on the contract's underlying term.

• Short-term interest rate futures: Typically refer to futures contracts with a term of less than one year. Representative examples include 3-month US Treasury bill futures and 3-month Eurodollar futures.
•  Medium-term interest rate futures: Generally, these futures have a term of more than one year but less than 10 years. Examples include 2-year US Treasury note futures, 5-year US Treasury note futures, and 2-year Eurobond futures.
• Long-term interest rate futures: These futures typically have a term of 10 years or more. The most representative example is the 10-year US Treasury note futures.

Foreign Exchange: These contracts involve an agreement between two parties to exchange one currency for another at a predetermined ratio at a future specified time. They are standardized contracts based on exchange rates and are used to hedge against currency risks. Foreign exchange futures were one of the earliest types of futures to appear.

In summary, futures trading is the practice of buying and selling standardized contracts of commodities or financial assets with set delivery dates, for the purpose of either hedging against or speculating future market movements.