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 a type of derivative contract whose value is linked to the price of an underlying asset.
- When trading stock market futures, the buyer agrees to purchase, or the seller agrees to deliver, a specified asset at a set price on a future date.
- These contracts are often used to hedge against potential losses from adverse price movements, whether involving individual shares, stock indices, or other financial instruments.
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.
