Futures trading involves contracts that obligate the buyer to purchase, or the seller to sell, a specific asset at a predetermined price on a future date. This asset can be anything from commodities and securities to other financial instruments. When the contract reaches its expiration date, the transaction must occur at the agreed-upon price, regardless of the market price at that time.
Typically, futures trading focuses on contracts tied to securities within the stock market. These contracts are based on the anticipated future value of a company’s shares or major stock indices such as the S&P 500, Dow Jones Industrial Average, or Nasdaq. Additionally, exchanges like the Chicago Mercantile Exchange facilitate futures trading involving a variety of underlying assets, including physical commodities, bonds, or even weather-related events.
How does Futures Trading Works
Futures contracts are standardized by quantity, quality, and asset delivery, making trading them on futures exchanges possible. They bind the buyer to purchasing and the other party to selling a stock or shares in an index at a previously fixed date and price.5 This ensures market transparency, enhances liquidity, and aids in accurate prices.
Stock futures have specific expiration dates and are organized by month. For example, futures for a major index like the S&P 500 might have contracts expiring in March, June, September, and December.6 The contract with the nearest expiration date is known as the “front-month” contract, which often has the most trading activity. As a contract nears expiration, traders who want to maintain a position typically roll over to the next available contract month. Short-term traders often work with front-month contracts, while long-term investors might look further out.1
When trading futures of the S&P 500 index, traders may buy a futures contract, agreeing to purchase shares in the index at a set price six months from now. If the index goes up, the value of the futures contract will increase, and they can sell the contract at a profit before the expiration date. Selling futures works the other way around. If traders believe a specific equity is due for a fall and sell a futures contract, and the market declines as expected, traders can buy back the contract at a lower price, profiting from the difference.
