Understanding Financial Considerations

Posted on: 19 September 2022

Futures provide an exciting opportunity for investors looking to dip their toes into new markets. However, futures contracts work differently from equities and other investments you may have invested in in the past. Aside from having their own rules, regulations, and investment strategies, there are also some potential pitfalls and special cases. 

Working with an established, experienced, and reliable broker is the best way to ensure you get the most out of your futures investments, but you'll still want to arm yourself with as much knowledge as possible. While a single article can never hope to turn you into an expert futures investor, these three top tips will help you understand some of the essentials and avoid common mistakes.

1. Cash Settlements Are King

All futures contracts include several critical parameters, but the settlement type is among the most important to understand. Settlement for a contract is either in cash or by physical delivery. Since all futures contracts rely on an underlying physical asset, it's necessary to determine what happens to that asset when the contract expires.

Physical settlement requires actual delivery of the asset, which is not something that typical traders want to (or even can) handle. If you're starting in futures trading, paying attention to your contract terms is crucial. While it's unlikely you'll ever need to take physical delivery of a contract, you may incur significant re-tendering fees from your broker.

2. Margins Are Wider

One advantage (and potential pitfall) of commodities trading is greater leverage availability. When trading securities, you'll typically need to deposit a larger percentage of your overall trade with your broker for a margin purchase. On the other hand, commodities brokers often allow traders to put down a much smaller deposit relative to the notional value of the underlying asset.

Remember that financial leverage has a lot in common with its physical counterpart. In other words, a small amount of work (your initial money) can result in a large amount of force (profit or loss). Utilizing the greater leverage available in futures trading can greatly increase your profits, but it's equally important to keep potential losses in mind.

3. Hours Vary

One of the easiest differences to overlook between stock market investing and futures trading is the difference in hours. Futures markets often trade outside of normal business hours, and various contract types may trade at different types. As with the greater potential for leverage, unusual futures hours can be both advantageous and disadvantageous.

The most critical thing is to fully understand the market you're trading in, to avoid surprise changes in your position when you aren't paying attention. By fully understanding where you're trading, you can use the atypical hours of the futures market as a critical part of your trading strategy. 

Reach out to a company like E-Futures to learn more.