Futures contracts are agreements to buy or sell a specific asset at a predetermined price on a future date. In the stock market, futures contracts are based on the future value of individual stocks or stock market indices like the S&P 500 or Nasdaq.
Beyond stocks, futures contracts can also involve physical commodities, bonds, or even weather events, and are traded on exchanges like the Chicago Mercantile Exchange.
Key takeaways
- Futures are financial contracts that derive their value from underlying assets.
- These contracts obligate the buyer to purchase or the seller to sell a specific asset at a predetermined price and future date.
- In the stock market, futures contracts can be based on individual stocks or stock market indices like the S&P 500 or Nasdaq.
- These contracts can help manage price risk by hedging against potential losses from unfavorable price movements.
How futures trading works
Futures contracts are standardized agreements to buy or sell a specific asset at a predetermined price and future date. They are traded on exchanges and offer a standardized way to trade stocks, stock indices, commodities, and other assets.
Stock futures contracts have specific expiration dates, with the nearest expiration date known as the front-month contract. Traders can buy or sell futures contracts to speculate on price movements or to hedge existing positions.
For example, if a trader believes the S&P 500 index will rise, they can buy a futures contract. If the index indeed rises, the value of the contract increases, allowing the trader to sell it for a profit. Conversely, if the trader expects the index to fall, they can sell a futures contract. If the index declines, the trader can buy back the contract at a lower price, realizing a profit.
