Futures Trading

🎢 Futures Trading: Your Ticket to Tomorrow’s Prices Today!

Imagine you could lock in today’s price for something you’ll buy next month. That’s the magic of futures!

🌟 The Big Picture: What Are We Learning?

Picture this: You’re a farmer growing wheat. Summer is here, but harvest won’t come until fall. You’re worried—what if wheat prices crash by then?

Enter futures trading—your time-traveling price machine! 🚀

We’ll explore:

• 📜 Futures Contracts – Official promises to trade later
• 🤝 Forward Contracts – Friendly handshake deals
• ⚖️ Futures vs Forwards – Exchange rules vs DIY deals
• 💰 Futures Margin – Your entry ticket deposit
• 📞 Margin Call – “Add more money, please!”
• 📊 Mark to Market – Daily report cards

📜 Futures Contracts: The Official Promise

What Is It?

A futures contract is like a promise written in stone.

Think of it like pre-ordering a toy that comes out next month. You agree TODAY on the price, even though you’ll get it LATER.

Key features:

• ✅ Traded on official exchanges (like a big marketplace)
• ✅ Standardized – same sizes, same rules for everyone
• ✅ Guaranteed – the exchange makes sure everyone keeps their promise

Simple Example

🌽 Corn Futures:

• You agree to buy 5,000 bushels of corn
• At $4 per bushel
• To be delivered in December

What happens?

• If corn price rises to $5 → You WIN! You still pay only $4
• If corn price drops to $3 → You LOSE. You still pay $4

graph TD
    A["Today: Agree on Price"] --> B["Wait Period"]
    B --> C["Delivery Date"]
    C --> D["Exchange Corn for Money"]

Real-World Use

🤝 Forward Contracts: The Handshake Deal

What Is It?

A forward contract is like making a promise with your neighbor.

Imagine your friend says, “I’ll sell you my bike for $50 next month.” You shake hands. Done! That’s a forward contract.

Key features:

• ✅ Private deal between two parties
• ✅ Customizable – any amount, any delivery date
• ❌ Not traded on exchanges
• ❌ Higher risk – what if your friend backs out?

Simple Example

🛢️ Oil Forward:

• A factory needs 10,000 barrels of oil
• They call an oil company directly
• “Let’s agree on $70 per barrel for June delivery”
• Both parties shake hands (or sign a contract)

No exchange involved. Just trust between the two.

graph TD
    A["Buyer & Seller Meet"] --> B["Negotiate Terms"]
    B --> C["Custom Agreement"]
    C --> D["Private Promise Made"]

Risk Alert! ⚠️

Counterparty Risk = What if the other person doesn’t keep their promise?

In forwards, there’s no referee. It’s just you and them.

⚖️ Futures vs Forwards: The Big Showdown

Side-by-Side Comparison

The Analogy

Futures = Buying concert tickets from Ticketmaster

• Standard seats, standard prices
• Protected by the company
• Can resell easily

Forwards = Buying tickets from a friend

• Can negotiate anything
• No protection if friend disappears
• Hard to transfer to someone else

graph TD
    A["Need to Lock Price?"] --> B{Want Protection?}
    B -->|Yes| C["Choose Futures"]
    B -->|Need Custom Terms| D["Choose Forwards"]
    C --> E["Trade on Exchange"]
    D --> F["Negotiate Directly"]

💰 Futures Margin: Your Entry Ticket

What Is It?

Margin is like a deposit when you rent an apartment.

You don’t pay the full rent upfront. You put down a deposit to show you’re serious. Margin works the same way!

Two types of margin:

1. Initial Margin 🎟️

The first deposit you make to enter a futures trade.

Example:

• You want to trade gold futures worth $100,000
• Initial margin might be only $5,000 (5%)
• You control $100,000 with just $5,000!

This is called leverage – like using a small key to open a big door.

2. Maintenance Margin 📊

The minimum balance you must keep in your account.

Example:

• Initial margin: $5,000
• Maintenance margin: $3,500
• If your account drops below $3,500 → Trouble!

graph TD
    A["Open Trade"] --> B["Pay Initial Margin"]
    B --> C["Trade is Active"]
    C --> D{Account Above Maintenance?}
    D -->|Yes| E["Keep Trading"]
    D -->|No| F["Margin Call!"]

Why Margin Matters

📞 Margin Call: “We Need More Money!”

What Is It?

A margin call is like your landlord calling to say, “Your deposit ran low. Add more money or move out!”

When your account balance falls below the maintenance margin, the exchange calls you (metaphorically) and says: “Add money NOW or we close your position!”

How It Works

Step-by-step:

1. 📉 Market moves against you
2. 💸 Your account loses money
3. ⚠️ Balance drops below maintenance margin
4. 📞 MARGIN CALL – broker contacts you
5. 💰 You must add money (back to initial margin level)
6. ⏰ Usually have 24 hours to respond
7. ❌ If you don’t pay? Position gets closed!

Simple Example

You trade oil futures:

• Initial margin: $5,000
• Maintenance margin: $3,500
• Oil price drops
• Your account falls to $3,000

MARGIN CALL! 📞

You must add: $5,000 - $3,000 = $2,000

graph TD
    A["Account: $5,000"] --> B["Price Drops"]
    B --> C["Account: $3,000"]
    C --> D["Below $3,500 Maintenance"]
    D --> E["MARGIN CALL!"]
    E --> F{Add $2,000?}
    F -->|Yes| G["Back to $5,000"]
    F -->|No| H["Position Closed"]

Pro Tip 🌟

Keep extra cash in your account. Don’t cut it close!

📊 Mark to Market: Daily Report Cards

What Is It?

Mark to Market (MTM) is like checking your score at the end of each school day.

Every day, the exchange looks at the closing price and says: “Did you win or lose today?” Then they add or subtract money from your account.

How It Works

Daily Settlement:

• At end of each trading day
• Exchange checks current futures price
• Calculates your gain or loss
• Adds money if you won
• Removes money if you lost

Simple Example

Day 1:

• You buy gold futures at $1,800/oz
• Day ends at $1,810/oz
• You gained $10/oz
• 💵 Exchange adds profit to your account

Day 2:

• Price drops to $1,790/oz
• You lost $20/oz from yesterday
• 💸 Exchange removes loss from your account

graph TD
    A["Trading Day Ends"] --> B["Check Closing Price"]
    B --> C{Price Changed?}
    C -->|Up| D["Add Profit to Account"]
    C -->|Down| E["Remove Loss from Account"]
    D --> F["New Balance"]
    E --> F
    F --> G["Next Day Begins"]

Why Mark to Market Exists

Benefits:

• 🛡️ Prevents big surprises – losses don’t pile up secretly
• 📊 Everyone knows the score – transparent daily
• 🔒 Reduces risk – catches problems early

The Connection to Margin Calls

Mark to Market → Account drops → Below maintenance → MARGIN CALL!

It’s all connected! The daily “report card” triggers margin calls when things go wrong.

🎯 Putting It All Together

The Complete Picture

graph TD
    A["You Want to Trade Futures"] --> B["Put Up Initial Margin"]
    B --> C["Trade is Active"]
    C --> D["Daily Mark to Market"]
    D --> E{Account OK?}
    E -->|Yes| F["Continue Trading"]
    E -->|No| G["Margin Call"]
    G --> H{Add Money?}
    H -->|Yes| F
    H -->|No| I["Position Closed"]

Quick Recap

🌈 Why This Matters

Futures trading powers the world!

• ✈️ Airlines lock in fuel prices
• 🍞 Bakeries lock in wheat prices
• ☀️ Energy companies manage risks
• 📈 Investors grow wealth

You’ve just learned how the pros manage tomorrow’s uncertainty TODAY!

🎉 You Did It!

You now understand:

• How futures and forwards work
• Why exchanges require margin
• What happens in a margin call
• How daily settlements keep everyone honest

The financial world just got a lot less scary! 🚀

Remember: Every expert was once a beginner. You’re on your way!