Futures

Futures are among the best-known and most widely traded derivatives. A futures contract is a binding agreement to buy or sell an underlying asset, such as a stock index, a government bond, a currency or a commodity, on a specified future date at a price fixed today. Unlike forwards, which are negotiated individually, futures are standardised and traded on an exchange, where a clearing house acts as the counterparty to both sides.

Futures were originally created to protect against price changes. A wheat farmer, for example, can sell futures to lock in a price for the coming harvest, while a mill can buy them to secure its purchase price, a classic form of hedging. Prices are formed purely by supply and demand, and both parties are obliged to fulfil the contract with no further conditions attached. In practice, most positions are closed before expiry rather than settled by delivery, and many contracts, such as index futures, are settled in cash.

Margin and leverage

Futures are traded on margin: instead of paying the full contract value, traders deposit an initial margin, and gains and losses are settled daily. This creates leverage. If a trader buys a contract at 100 points and the price rises to 105, the profit is 5 points multiplied by the contract's value per point; if the price falls to 95, the loss is calculated in the same way. Even small price movements can therefore lead to large gains or losses relative to the capital deposited, and losses can exceed the initial margin.

Popular futures markets

Liquid futures, i.e. those that are traded frequently, are particularly well suited as trading instruments because of their transparency. Futures on major stock indices such as the DAX, the Dow Jones Industrial Average, the S&P 500 and the Euro Stoxx 50 are especially popular. Interest rate futures on German and US government bonds, such as the Euro-Bund future and the 10-Year T-Note future, also offer particularly high liquidity.