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Futures

Futures are financial contracts traded on exchanges that obligate buyers and sellers to purchase or sell an asset (like stocks, commodities, or indices) at a predetermined price on a specific future date. They’re powerful tools for investors to hedge risks, speculate on price movements, or gain exposure to markets without owning the underlying asset. In the stock market, futures often tie to indices like the S&P 500 or individual stocks, offering a way to bet on or protect against price changes.
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A futures contract is an agreement between two parties: one agrees to buy (the "long" position), and the other to sell (the "short" position), at a set price and date. For example, an S&P 500 futures contract might lock in a price of 5,000 points for delivery in three months. Unlike stocks, you don’t own the asset now—you’re committing to a future transaction. Contracts are standardized (size, expiration) and traded on exchanges like the CME (Chicago Mercantile Exchange).

  1. Contract Creation: A futures contract specifies the asset (e.g., 100 shares of a stock index), price, and expiration date (e.g., June 30). Example: You buy an S&P 500 futures contract at 5,000 points for $250 per point (contract value: $1.25 million).
  2. Margin: You don’t pay the full value upfront. Instead, you deposit a "margin" (e.g., 5-10% of the contract value) as collateral.
  3. Daily Settlement: Gains or losses are calculated daily based on the asset’s price movement (mark-to-market). If the S&P 500 rises to 5,050, you gain $12,500 ($50 x 250); if it drops, your margin account adjusts downward.
  4. Expiration: On the expiration date, the contract settles—either by delivering the asset (rare for stock futures) or cash settlement (common). Most traders close positions before expiry to avoid delivery.
  5. Leverage: Because you control a large asset with a small margin, futures amplify both profits and losses.
  • Hedging: A portfolio manager with $1 million in stocks might short S&P 500 futures to offset a market drop.
  • Speculation: A trader bets on a stock index rising, profiting if the price exceeds the contract’s locked-in level.
  • Arbitrage: Traders exploit price differences between futures and the underlying asset.
  • Leverage: Control big positions with little capital.
  • Flexibility: Profit in rising or falling markets.
  • Liquidity: Futures markets are active and easy to trade.
  • Leverage magnifies losses— a small price drop can wipe out your margin.
  • Complexity: Requires understanding market trends and timing.
  • Obligation: Unlike options, you must fulfill the contract unless you exit early.

Suppose you think the S&P 500 (currently 5,000) will hit 5,200 in three months. You buy a futures contract at 5,010 ($250 per point). If it reaches 5,200:

  • Profit = (5,200 - 5,010) x $250 = $47,500.
    If it drops to 4,800, you lose $52,500. You only put down ~$62,500 (5% margin), so the stakes are high!

Futures are like a high-stakes handshake on tomorrow’s prices. They let investors lock in deals, hedge bets, or chase gains with leverage, but the risk matches the reward. In the stock market, they’re a fast-paced tool for navigating uncertainty—just don’t shake hands unless you know the game.