A Trader's Guide To Futures: Guide - CME Group
CME GROUP EDUCATIONA Trader’s Guide to FuturesThought Leadership with a Global PerspectiveHow the world advances
cmegroup.com/educationTABLE OF CONTENTSintroductionSECTION 1A Trader’s Guide to FuturesWhat Are Futures? 4SECTION 2Who Trades Futures? 6CME Group offers the widest range of tradable productsavailable anywhere — all on a single platform: interestSECTION 3Why Trade Futures? 9SECTION 4How Does a Trade Work? 13SECTION 5How Do I Get Started? 24SECTION 6rates, stock indexes, currencies, agriculture, energy,metals (industrial and precious) and alternativeinvestment products, such as weather and real estate. Inmore than 150 countries, our centralized global exchangeFutures Quiz 30delivers transparent pricing and equal access virtuallyaround the clock. With the backing of CME Clearing,the leading derivatives clearing facility in the world, thefinancial integrity of our markets is unsurpassed.2
This is your introductory guide to trading futures.If you’re a trader who is interested in branchingout from equities or cash FX into futures, thisguide will provide a great starting point. If youalready know something about futures trading,you can jump to any chapter for a review orto the back of the booklet and test yourknowledge in our Futures Quiz.3
cmegroup.com/educationSECTION 1What Are Futures?In the United States, trading futures began in the mid-19th century with theestablishment of central grain markets where farmers could sell their productseither for immediate delivery, also called the spot or cash market, or for forwarddelivery. These forward contracts were private contracts between buyers andsellers and became the forerunner of today’s exchange-traded futures contracts.Both forward contracts and futures contracts are legal agreements to buy or sellan asset on a specific date or during a specific month. Where forward contractsare negotiated directly between a buyer and a seller and settlement terms mayvary from contract to contract, a futures contract is facilitated through a futuresexchange and is standardized according to quality, quantity, delivery time andplace. The only remaining variable is price, which is discovered through anauction-like process that occurs on the Exchange trading floor or via CME Globex,CME Group’s electronic trading platform.4
CME group Education Section 1Although trading began with floor trading of traditional agricultural commodities such as grains and livestock,exchange-traded futures have expanded to include metals, energy, currencies, equity indexes and interest rateproducts, all of which are also traded t RatesStandardized contracts for the purchaseand sale of financial instruments or physicalcommodities for future delivery on a regulatedcommodity futures exchange.forward contractA private, cash-market agreement betweenEnergyMetalsa buyer and seller for the future delivery of acommodity, at an agreed upon price. In contrastto futures contracts, forward contracts are notstandardized and are non-transferable.spot marketA market where cash transactions for thephysical or actual commodity occur.EquityFXCME GlobexThe first global electronic trading system forfutures and options has evolved to become theworld’s premier marketplace for derivativestrading. With continual enhancements, theplatform has effectively enabled CME Group,already known for innovation, to transform itselfinto a leading high-tech, global financialderivatives exchange.5
cmegroup.com/educationSECTION 2Who Trades Futures?Conventionally, traders are divided into two main categories, hedgers and speculators.Hedgers use the futures market to manage price risk. Speculators on the other handaccept that risk in an attempt to profit from favorable price movement. While futureshelp hedgers manage their exposure to price risk, the market would not be possiblewithout the participation of speculators. They provide the bulk of market liquidity, whichallows the hedger to enter and exit the market in an efficient manner. Speculatorsmay be full-time professional traders or individuals who occasionally trade. Some holdpositions for months, while others rarely hold onto a trade more than a few seconds.Regardless of their approach, each market participant plays an important role inmaking the futures market an efficient place to conduct business. The following pageswill provide brief profiles of the most common types of market participants.“ When we started 21 years ago, the trading was self-contained. Overthe last 15 years, it’s broadened so much with electronic tradingthat people now have access to these markets from any place in theworld. It’s been interesting to see how the markets have grown andmatured because of that.”— Jim Iuroio Broker6
CME group Education Section 2What Types of Traders are There?HedgersHedgers have a position in the underlying commodity. They use futures to reduce orlimit the risk associated with an adverse price change. Producers, such as farmers,often sell futures on the crops they raise to hedge against a drop in commodity prices.This makes it easier for producers to do long-term planning. Similarly, consumersProducersHedge against a dropin commodity prices.such as food processing plants often buy futures to secure their input costs. Thisallows them to base their business planning on a fixed cost for core ingredients, suchas corn and wheat. Other examples include: airlines hedging fuel costs or jewelrymanufacturers hedging the cost of gold and silver. This makes it easier for thesecompanies to manage price risk and stabilize the cost passed on to the end-user.Individual TradersMany speculators are individuals trading their own funds. Traditionally, individualtraders have been characterized as individuals wishing to express their opinion about,or gain financial advantage from, the direction of a particular market. Electronic tradinghas helped to level the playing field for the individual trader by improving access toprice and trade information. The speed and ease of trade execution, combined with theapplication of modern risk management, give the individual trader access to marketsConsumersHedge against a rallyin commodity prices.and strategies that were once reserved for institutions.Portfolio ManagersA portfolio or investment manager is responsible for investing or hedging the assetsof a mutual fund, exchange-traded fund or closed-end fund. The portfolio managerimplements the fund’s investment strategy and manages the day-to-day trading.Futures markets are often used to increase or decrease the overall market exposure ofa portfolio without disrupting the delicate balance of investments that may have takena significant effort to build.7
cmegroup.com/educationProprietary Trading FirmsProprietary trading firms, also known as prop shops, profit as a direct result of theirSpeculatorstraders’ activity in the marketplace. These firms supply their traders with the educationand capital required to execute a large number of trades per day. By using the capitalresources of the prop shop, traders gain access to more leverage than they would ifthey were trading on their own account. They also gain access to the type of researchand strategies developed by larger institutions.HedgersHedge FundsA hedge fund is a managed portfolio of investments that uses advanced investmentstrategies to maximize returns, either in an absolute sense or relative to a specifiedmarket benchmark. The name hedge fund is mostly historical, as the first hedge fundstried to hedge against the risk of a bear market by shorting the market. Today, hedgefunds use hundreds of different strategies in an effort to maximize returns. The diverseand highly liquid futures marketplace offers hedge funds the ability to execute largetransactions and either increase or decrease the market exposure of their portfolio.Market MakersMarket makers are trading firms that have contractually agreed to provide liquidityto the markets, continually providing both bids (an expression to buy) and offers (anexpression to sell), usually in exchange for a reduction in trading fees. Increasinglyimportant are electronic market makers who as a group, provide much of the marketliquidity that allows large transactions to take place without effecting a substantialchange in price. Market makers often profit from capturing the spread, the smalldifference between the bid and offer prices over a large number of transactions, or byDefinitiontrading related futures markets that they view as being priced to provide opportunity.LiquidA characteristic of a security or commoditymarket with enough volume and open interest(positions) to allow for entry and exit at a fairand efficient price. Market participants areinclined to seek out liquid investments sothat their trading activity will not influencethe market price.8
CME group Education Section 1SECTION 3Why Trade Futures?Futures provide a fast and cost-effective way for you to access financial and commoditymarkets around the clock. Increased interest in global markets has accelerated mediaattention and attracted the interest of traders from around the world. From their studyof the markets, traders develop a perspective on the direction of commodity prices,energy prices, metal prices, currencies, interest rates and stock indexes. CME Groupoffers products across all major asset classes giving you a direct and transparentmethod to act on your insight and participate in market trends.9
cmegroup.com/educationLeverage on futures contracts is created through the use of performance bonds,Maximizing Capital Efficiencyoften referred to as margin. This is an amount of money deposited by both the buyerThe leverage available in futures trading allows you to utilize your capital more efficiently.and seller of a futures contract and the seller of an option contract to ensure theirFor example, if you have 200,000 and you want to speculate on the direction of theperformance of the contract terms. The performance bond may represent only aS&P 500, for the purposes of this illustration, you have three choices:fraction of the total value of the contract, often 3 to 12%, making futures a highlyleveraged trading vehicle. Therefore, futures contracts represent a large contract valuethat can be controlled with a relatively small amount of capital. This provides the traderwith greater flexibility and capital efficiency. » Buy 200,000 of stock using all available capital. This can be done bypurchasing an Exchange-Traded Fund (ETF), which for this example would be SPY.SPY seeks to replicate, net of expenses, the S&P 500 Index. It is regulated as, andtrades in, equity (stock) like shares. Your exposure would be 200,000 worth ofSPY shares. » Buy the same stock (ETF-SPY) on margin, taking advantage of the 2:1 leverageWhat do we mean by “leveraged”?The E-mini S&P 500 Stock Index futures contract could have a value of 67,500,in equities. This allows you to control the same portfolio of stocks (ETF-SPY) byutilizing 100,000 of available capital. » Buy futures on margin, taking advantage of the approximately 10:1but you would be able to buy or sell this contract by posting a performance bondleverage available with E-mini S&P 500 contracts. This allows you to control theof about 6,000, which is only 9% of the contract value.same portfolio of stocks by leveraging 20,000 of available capital. The three E-miniS&P 500 contracts represent approximately the same 200,000 of exposure of theS&P 500 index stocks.The ability to leverage may remind you of buying stocks on margin. However, in equitymarkets, buying on margin means you borrow money to make the purchase. In theIn each case, you have exposure to the same type of market risks and opportunities,futures markets, your performance bond is not partial payment for the product. It isbut in the final example, you gain the same amount of market exposure while tyinggood-faith money you post to ensure you are able to meet the day-to-day obligationsup significantly less of your available capital. Please note the figures above representof holding that position. Both buyers and sellers in futures post performance bonds.margin and performance bond amounts that are subject to change.Positions are then marked-to-market on a twice daily basis, where profits are creditedand losses are debited from your account.RegulationFutures markets are regulated by the U.S. Commodity Futures Trading Commission(CFTC), an independent government agency formed in 1974 to foster open, competitiveDefinitionand financially sound futures and options markets, and to protect market users and thepublic from any fraud, manipulation or abusive practices.performance bondThe minimum amount of funds that must bedeposited by a customer with his broker, by abroker with a clearing member or by a clearingmember with the Clearing House.10Tax AdvantagesTrading futures may offer specific tax advantages compared to other instruments suchas stocks. Be sure to discuss your particular tax obligation with your tax advisor.
CME group Education Section 3What Differentiates CME Group Futures Markets?Portfolio DiversificationTransparencyCME Group futures products allow you to more easily diversify your portfolio.CME Group provides a centralized marketplace where all prices are known to everyone.CME Group offers futures products from all major assets classes, including foreignTrading is open, fair and anonymous. Comprehensive price and transaction datacurrencies such as the European euro, the British pound and the Japanese yen, Stockis distributed in real time, providing a clear or transparent view of the market toIndex Products like the S&P 500, NASDAQ-100 and Dow Jones Industrial Average,all participants.interest rate and treasury products, commodities including grains and oil seeds, energysuch as crude oil, natural gas, gasoline and ethanol, metals including gold and silver,and weather and housing indexes.Electronic Access Around the ClockCME Group provides customers around the world with the ability to navigate economicuncertainty, manage risk and leverage financial opportunity virtually 24 hours aWhen equity and bond markets are volatile,professionals may be more likely to hedge their stockand bond portfolios using equity index and interestrate futures. In addition, they may diversify their assetsthrough commodity and currency futures becauseof their low correlation to investments in stocksand bonds.day. Available from Sunday evening through late Friday afternoon, the CME Globexelectronic trading platform connects customers in more than 150 countries who canreact to change as it happens.Segregated AccountsCFTC regulations require customer positions and collateral to be segregated orkept separate from the positions and collateral of the FCM clearing member. Therequirements apply directly to the activity and accounting by the clearing member andare further detailed in CME rules. CME Clearing’s Financial and Regulatory SurveillanceDepartment regularly reviews clearing member records to monitor compliance withLiquiditycustomer protection requirements. The integrity of customer protection relies on theaccuracy and timeliness of the information provided to CME Clearing by its clearingThe established futures markets offered by CME Group are highly liquid. By providingmembers. Violations by a clearing member of these requirements are consideredelectronic access to a broad spectrum of products on a single platform, our marketsserious infractions and can result in imposition of significant regulatory penalties.attract a wide range of participants who transact millions of contracts on a daily basis.This volume makes it easier for traders to execute orders of any size quickly andefficiently, without effecting a substantial change in price.DefinitionVolatilityA measurement of the change in price over agiven time period.11
cmegroup.com/educationFinancial SafeguardsBy serving as the counterparty to every transaction, CME Clearing becomes theCME Clearing, which is owned by CME Group, provides industry-leading financialbuyer to every seller and the seller to every buyer, substantially reducing the financialintegrity that is the standard for making markets more efficient. CME Clearing isperformance risk of each market participant’s position in CME Group products. Further,responsible for settling trading accounts, clearing trades, collecting and maintainingby marking positions to market twice each day, CME Clearing helps to eliminate theperformance bond funds, regulating delivery, facilitating the option exercise processaccumulation of losses or debt. This helps individual customers manage their risk andand reporting trade data.also helps contain risk for the market as a whole.The presence of a central counterparty like CME Clearing is an important advantageCentral Counterparty Clearing Modelcompared to such over-the-counter markets as the spot or cash Forex market.ClearingOver-the-counter transactions are made between two private parties with no centralclearing counterparty to extend credit or assure performance of the agreement (asshown in the Bilateral Model to the right). This leaves participants at risk for a potentialdefault of the other party, which translates into increased capital requirements, creditinefficiencies and higher overall credit risk.DefinitionFirm ACustomersFirm BBuyingFirm ASellingFirm BCustomersCME clearingThe division of CME Group that confirms,Bilateral Modelclears and settles all CME Group trades.CME Clearing also collects and maintainsperformance bond funds, regulates delivery,facilitates the option exercise process andreports trading data.Over-the-counter (OTC)A market in which custom-tailored contracts arebought and sold between counterpartiesand are not exchange-traded.12Firm ACustomersFirm ASellingFirm BBuyingFirm BCustomers
SECTION 4How Does a Trade Work?Before we go through specific examples, there are some key terms and concepts youneed to understand.Contract SizeBy definition, each futures contract has a standardized size that does not change. Forexample, one contract of corn represents 5,000 bushels of a very specific type andquality of corn. If you are trading British pound futures, the contract size is always62,500 British pounds. The E-mini S&P 500 futures contract size is always 50 timesthe price of S&P 500 index. Specifications for all products traded through CME Groupcan be found at cmegroup.com.Contract ValueContract value, also known as a contract’s notional value, is calculated by multiplyingthe size of the contract by the current price. For example, the E-mini S&P 500 contractis 50 times the price of the index. If the index is trading at 1,425, the value of oneE-mini contract would be 71,250.Tick SizeThe minimum price change in a futures or options contract is measured in ticks. A tickis the smallest amount that the price of a particular contract can fluctuate. Tick sizevaries from contract to contract. A tick in the E-mini S&P 500 futures contract is equalto one-quarter of an index point. Since an index point is valued at 50 in the E-mini,one tick is equivalent to 12.50.13
cmegroup.com/educationPrice LimitsReal-World ExamplesSome futures markets impose limits on daily price fluctuations. A price limit is themaximum amount the price of a contract can move in one day based on the previousday’s settlement price. These limits are set by the Exchange and help to regulateExample 1: Commercial Tradersdramatic price swings. When a futures contract settles at its limit bid or offer, the limitmay be expanded to facilitate transactions on the next trading day. This may helpThe following are a few hypothetical scenarios of how institutional market participantsfutures prices return to a level reflective of the current market environment.use futures to hedge market risk.Mark-to-MarketHedging Corn PricesFutures contracts follow a pra
Although trading began with floor trading of traditional agricultural commodities such as grains and livestock, exchange-traded futures have expanded to include metals, energy, currencies, equity indexes and interest rate products, all of which are also traded electronically. FUTURES Standardized contracts for the purchase
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