The Different Types of Futures Market Explained

The futures market is appealing to investors that want to protect the price of a specific commodity or asset, and by extension their portfolio and operations, and to the speculative investor that feels they have good insight into the world, current and future events, and a certain commodity or asset.

Throw in favourable tax regulations and it becomes more apparent as to why futures is in demand.

Understanding the different types of futures market is therefore essential before you start trading. So let’s explore this in more depth.

One thing, none of this is financial advice but instead is to help you gain valuable insights into the futures market.

Different Types of Futures Market Explained

In essence, there are four different types of futures markets. They are:

• Commodity Futures
• Currency Futures
• Interest Rate Futures
• Stock Futures

Commodity Futures

Commodity futures are physical assets. Natural gas, food grains, and oil are among the most popular commodities and these are bought and sold by investors in relation to market conditions. As the assets are physical they are the security for the contract.

They are used to manage risk and a good example of this are food grains. A farmer wants to guarantee the price come harvest time and signs a futures contract to sell his or her produce for a particular price on a certain date. This guarantees income for the farmer and is protected from unfavourable market conditions, or put simply price drops.

Currency Futures

The idea of currency futures is that they offer protection from currency market volatility that tends to happen in long term international currency trading. Here, the buyer and seller agree to exchange two currencies on a future date. Given the fluctuating nature of currency trading, the contracts are often closed early when a mutual position for both the buyer and seller is realised.

Interest Rate Futures

Interest rate futures use money market or bond market assets such as government bonds and bills to form inflation related contracts. The idea, is that interest rate futures are a hedge against inflation which when high as we are seeing at the moment, can put extreme financial pressure on the markets and businesses.

Stock Futures

They are often used to speculate, trade, and hedge against risk. Investors use single stock futures in a hedging capacity, protecting against price fluctuations of a certain stock. While the stock market index futures track the movement of an entire index.

As the futures market is a buy and sell contract, stock futures financial derivative contracts obligate both parties to buy and sell a certain stock upon expiration of the contract. They tend to appeal to investors who have a significant stake in a stock or a few stocks where price protection is essential to their investments.

Understand Leverage and Margin in Relation to Futures

Now you have an insight into the different types of futures contracts, next it is imperative that you understand leverage and margin in relation to futures which works a little differently than what you may have experienced in the equities market.

To access the futures market you have to go through a licensed broker. In the case of trading platforms such as Plus500, you find a contract you’re interested in and open a position for x amount which is a small percentage of the total contract value. The x amount is also your margin. The total value of the contract minus your margin is your leverage.

Should the value of the contract fall the broker will ask you for a maintenance margin fee which corresponds to how much the value has fallen.

• Strengths – you can open a position for a small percentage of the value of the contract.
• Weakness – you are potentially exposed to considerable risk, as clients can lose more than their original investment.

Options vs. Futures

Options and futures share similarities but also have significant differences and there is a difference between American and European options.

• American options – American options have similar asset purchase contracts as futures but there is no obligation to buy or sell at the end of the contract. The contract can be bought and sold before the expiration date.
• European options – European options have similar asset purchase contracts as futures too. They carry no obligation to buy or sell an asset at contract expiry. The difference between American options and European options is buying and selling can only happen at the end of the contract.

By now, you have a good idea of the different types of futures markets and have better insights into the risks and rewards. As other with other investment options world events and inflation play a significant part in the price of an asset.