Investing with futures
A future is an investment form that is also called a derivative , which always relates to something, such as a share or an index such as the AEX. Futures are mainly used by professional entrepreneurs to make a favorable price agreement for the future. The buyer and seller then agree on what will be paid in costs in the future (English: future). The product that is negotiated is the underlying value. This can be anything, such as:
- Various agricultural products, such as potatoes or coffee
- Metals, such as gold or silver
- Certain raw materials , such as oil, copper or lead
- Shares in a company or other types of financial securities
The costs of a future
A big advantage of futures is that it is low in costs in terms of closing the contract. Often the closing costs for shares and bonds are much higher and the costs often amount to 0.15-0.20% of what the value is. Trading in futures can often start from € 2.80.
The risks of investing in futures
Investing in futures involves major risks . As an investor, it is therefore important to always keep in mind that futures are derivative products and involve risks. The potential return on futures is many times higher, which sounds attractive to many investors, but which also causes problems at the same time. Therefore, make sure that you set limits when investing in futures. This will prevent your entire investment from evaporating in one go.
Trading futures yourself
Of course it is possible to trade in futures yourself, this is done via an online broker . Because you can invest in futures with a broker, you do not have to keep an eye on the administrative matters yourself. You receive the difference in price that you achieve from the underlying effect. It is important that you have the right knowledge and experience before you start trading in futures yourself. If you would like to trade in futures but you are not yet well prepared, you can also leave this to a professional asset manager. This ensures that you have fewer risks and you run less chance of big losses.
The payment
In general, futures are mainly used on the stock exchange with the aim of being able to profit from price differences due to the underlying securities of the stock exchange. An important characteristic of the future is that no payment takes place at the beginning of the contract. Of course, the bank must be guaranteed a payment, which is usually arranged in the form of a margin obligation. The payment of the future only takes place after the term of the contract has ended.
There are two types of contracts in a future, which differ in the type of delivery. For example, there are physical delivery futures and cash delivery futures.
Physical delivery
With a physical delivery, an underlying product is delivered to your home. This may be impractical and is not ideal for every entrepreneur. Usually, there is no physical delivery and the entrepreneur concludes the contract before the contract expires.
Cash levering
Usually, delivery takes place in cash. This can be on a share, for example. When the price increases, you receive money. Futures are often also used to cover risks. Entrepreneurs then use futures to be paid out in the event of, for example, a different temperature. This can be particularly advantageous if you have an ice cream shop or sell a seasonal product. With a cash delivery, a daily settlement takes place in which the price difference is calculated in money. This is also known as ‘marking to market’. When you have purchased a future on the AEX index, you receive an amount in money when this index has increased. So no payment takes place at the time of opening the contract and money is deposited or received almost every day through changes in the price and through changes in the underlying value.
How is the price of a future determined?
How the price of a contract or future is determined depends on various properties. One of these is the underlying security. The futures price is often more or less the same as the current price of various underlying assets (also called ‘spot price’), but never completely.
It is often the case that when the term is longer, the difference between the price and the underlying value is also often greater. The price is also influenced by a difference in interest rates and the dividend that still has to be paid out. This ensures that you need less money to buy the future than the costs of the underlying securities. When the period is long, the price of the future will also often be higher.
A future usually does not pay dividends, and it is often the case that the more you miss out on dividends, the greater the discount on the future will be in relation to the share. Some forms of futures do pay dividends; such as CFDs (contract for difference).
When a futures price exceeds the current price, this is also called ‘contango’, and when the futures price falls below the spot price, this is called ‘backwardation’. However, backwardation is also used in temporary price disturbances, such as when there is a sharp increase in the oil price due to impending shortages.
Rolling over a future
When the contract period has ended, the futures expire. However, if the entrepreneur wants to hold the future for longer, the entrepreneur can choose to roll over the future. Rolling over can take place when the entrepreneur purchases a future and then sells it with the same underlying value, but a different expiration date. There are often costs involved.
Rolling forward futures is not very common in practice. Futures are often used primarily for short-term trading and to cover investment risks by means of hedging (a type of hedge to compensate for potential losses).
Compare brokers and start investing in futures
Are you excited about investing in futures after reading this article? Compare futures providers and find the broker that suits you best!