‘A Futures contract is a contract between 2 parties to buy / sell a standardised quantity of a specified product through an established futures exchange at a price determined today for a standard future date’

What are Futures Contracts - Futures are termed as derivatives, in the same asset class as warrants and options. Being a derivative means that they are derived from a underlying asset.  Therefore, almost everything under the sun can have a futures contract written upon it! ie. Soybean futures are based on the cash soybean prices, and stock index futures are based on the cash price of a basket of stocks.

Types of Futures Contracts - Futures contracts can be broadly divided into 4 main categories.

1. Commodities - Soft commodities (Soybeans, Coffee, Cocoa etc), Base Metals (Aluminium, Copper, Zinc etc) and Precious Metals (Gold, Silver, Platinium)
2. Interest Rates - Bonds, Treasury notes, 3-mth Eurodollar, Fed Funds
3. Forex - Eur, Jpy, Gbp, Usd
4. Stock Index -  Dow Jones, Nasdaq, S&P, Nikkei, HangSeng, SiMSCI

Contract Specifications - Futures contracts are traded in lots and quantity of each lot is standardised and pre-determined by the exchange. For example, 1 lot of CBOT corn futures is 5000 bushel and 1 lot of HangSeng index futures is price x Hkd 50.

Margins - When initiating a position in a futures contract (buy or sell), you are only required to put up a good faith deposit called the initial margin. The initial margins are fixed by the Exchange, and changes from time to time based on market volatility, contract size and liquidity. If your account equity balance falls below 80% of the initial margin, known as the maintanence margin, there will be a margin call and you will be required to reduce your positions or top up additional funds to meet the margin call to bring your account equity back to the initial margins required.

Daily settlement price - At the end of each trading day, the exchange calculates a settlement price. All open positions will be marked-to-market at this settlement price, and the difference between the transacted price and this settlement price (unrealised profit or loss) will be taken into your account and also reflected in your statements.

Expiry Date - Each futures contract has a contract month (ie Dec09 Nikkei Futures) and will expire on a specified future date. Some contracts are listed monthly and others quarterly, while most commodities are listed according to their harvesting months. Every contract month is different (ie. Dec09 Nikkei Futures is a different contract from Sep09 Nikkei Futures), and usually only the current contract months are active.

Settlement - At the expiration date, all futures contracts are either cash-settled (based on the final settlement price calculated by the futures exchange) or delivered. As it is not possible to deliver a basket of stocks of different weightage, ALL stock index futures are cash settled.

Risk - Because of the use of leverage, whereby you only put up a fraction of the total contract size (known as initial margin) to initiate a position, futures trading is like trading through a magnifying glass - with the potential for profits and losses greater than trading on a non-leveraged basis.

For example, Trader A buys Sgd 100,000 worth of a share and the share price falls by 10%. Trader A loses 10% of his initial investment (Sgd 10000). On the other hand, Trader B buys a stock index futures contract of sgd 100,000 contract size, putting up an initial margin of Sgd 10,000. If market falls by 10%, Trader B loses 100% of his investment. Similarly, if the product increase in value by 10%, Trader A makes 10% while Trader makes a 100% return on his initial capital outlay.

Therefore, being a futures trader will require more skills, knowledge and groundwork as he does not only must know how to trade but also how to manage his account and train his mindset. See Art of Trading.