Common Types of Futures Contracts

By Don Dawson | August 15, 2019

Trading futures on listed futures exchanges has been around for over 200 years.  Currently we have two futures exchanges in the United States – Chicago Mercantile Exchange Group (CME Group) and the Intercontinental Exchange (ICE).  These exchanges provide a central location for futures contracts to be traded on electronic trading platforms, thereby allowing access to the futures markets for approximately 23 hours per day (excluding weekends).  These exchanges also write the specifications for their respective futures contracts, enforce the rules and assure trading business is conducted in a professional and orderly fashion each day.

While there are some similarities in the exchanges that futures contracts trade on,  each is unique.  When you hear traders say they’re trading futures, they are making a very broad statement.  This is because there are many different types of futures to trade.

As a futures trader you have a choice to trade either the financial or the physical commodity futures contracts.  Most new traders starting out in futures typically trade financial futures simply because they were already trading equity products (Stocks) before coming into the futures arena.  Financial futures then become a lateral move for new futures traders. Note, however, there are many differences between trading physical futures vs. the equity market.

Let’s breakdown these two different areas of the futures market. We will try to give you a clearer picture of what you might be getting into.; We will also try to  help you decide which type of futures may be your market of choice.

Choosing Between Financial Futures vs. Physical Commodity Futures Trading

Infographic listing the two main types of futures contracts and their sub parts

Like the stock market where there are over 8,500 stocks listed to trade, the futures market has many hundreds of contracts.  And just like the stock market, traders will not trade all the available futures markets.

Futures traders should look for markets that have good liquidity (volume), fair bid and ask spreads for entering/exiting trades; they should also have a good understanding of the market they are trading.  Unfortunately, not all futures markets should be traded by speculators.  For example, there are futures contracts for  uranium, butter, whey, lumber, black sea wheat, real estate, weather markets, etc.  Those markets are used by commercial traders to hedge price risk of the physical commodity that they own or wish to own later.  We, as speculators, want to avoid these types of low liquidity markets for risk management purposes. There are many other types of futures contracts to choose from, however.

Futures Asset Groups

Financial Futures Physical Futures
Stock Indexes Energy Markets
Currency Markets Metals
Interest Rate Products Agricultural
Softs

Financial Futures Contracts

Financial Futures contracts tend to be paper assets. These products allow a trader/investor to participate in products closely related to Equity markets while having some advantages in doing so. Financial Futures allows 23 hour trading, reducing the daily gap risk that many Equity traders experience because Equities only trade for approximately 7 hours per day. Financial Futures also require less capital to trade than Equity products. Using margin in Futures, a trader only has to deposit approximately 5-10% of the contract value compared to 50% in the Equity market when using margin. The Financial Futures market, though, will be affected by news/economic reports in the same way that the Equity markets are.

Forces That Drive Financial Futures Prices:

Stock Index prices are affected by how the stock market is performing. As Stocks come under selling pressure so will the Stock Indexes. The reverse is true for buying pressure. Interest rates can have an impact on Stock Indexes as well. Higher yields in those products creates competition for money searching for safer investments.

Currency market prices can be impacted by interest rates around the world. Capital tends to move to Currency markets whose countries have the highest yielding interest rates. Geo-politics can have an impact on Currency prices too. A strong, well run government will make investors feel safer investing in that country’s currency compared to a country whose government is in turmoil.

Interest rate prices and yields can be driven by several factors. An expanding economy in a country might give their central bank reason to believe inflation is near. They will then begin to raise interest rate yields to slow the expansion. If a country’s economy is contracting then their central bank may lower interest rate yields in an attempt to stimulate their economy by making borrowing cheaper, allowing companies to grow their earnings again.

Physical Futures Contracts

Physical Futures markets are a little more advanced. These markets are typically for items extracted from the Earth and produced or processed before being sent out to end users. There are many factors that can impact these markets causing price changes.  Factors like weather, geo-politics (tariffs, labor strikes, etc.), seasonality, disruptions to supply/demand (such as transportation issues) and even diseases that impact crops and livestock can be all be relevant with respect to price.

Energy futures contracts are the highest demand commodity we have. There is a crude oil product that trades on its own in one of the world’s most liquid (no pun intended) contracts. Byproducts of crude oil are gasoline and heating oil.  Depending on the time of year, crude oil demand is determined by a few seasonal and fundamental factors. In early spring the demand for gasoline begins to build for the summer holiday driving season. In the fall the demand shifts towards heating oil to warm homes in the cold winter months. However, other factors such as refinery fires, shutdowns, etc. can disrupt supply distribution and cause price reaction, too.

The natural gas contract is a very seasonal market. As with heating oil, natural gas is used for heating homes in the winter. In addition, it is also used for air conditioning units used in very large buildings such as manufacturing plants. Vehicles at the commercial level (Fed Ex, UPS, U.S. Postal Service etc.) are also beginning to use more natural gas.

Metals markets are very diverse as well. Here you will find gold, silver, copper and platinum. Gold prices can be driven by seasonal factors with early fall usually being a low demand time for gold right before we head into the higher demand times of the India wedding season, holiday gift giving and then the Chinese New Year holiday. Gold is primarily used for jewelry more than as an industrial metal.  Central banks around the world keep gold in their vaults to hedge against any potential inflation that may come.

Silver, copper and platinum are additional types of industrial metals. Copper can be impacted by the housing market due to the amount of copper used to build a home. The summer building season usually brings about higher prices for copper.  Platinum is used in catalytic convertors in automobiles and jewelry as well. Waning auto sales can obviously have an impact on platinum prices. Silver has some industrial metal value, but not like it did back in the day of dental and photography uses.

Agricultural products can include grains and livestock. Both of these are heavily influenced by seasonal patterns that can make price go up or down. With grains, they tend to be planted and harvested at the same times each year. This creates a well- known seasonal pattern of higher prices in the spring than in the fall when supply causes lower prices. Livestock is another seasonal commodity.  From the supply side, hogs and cattle are bred and slaughtered the same months each year, while summer grilling season increases demand. Certain times of the year also cause more demand for pork than beef and this contributes to price swings.

Grains can be affected by weather. Too much rain can be as bad as not enough. Too early of a frost can ruin a crop. Diseases in the crops can ruin a good year of planting. So, while grain traders follow the seasonal patterns, they must also be aware of weather conditions.  Currently we are experiencing a trade war with China. This is causing a supply/demand issue and market participants are struggling to figure out what the outcome will be.  Just like all events that affect our markets, this, too, will end  and it will be replaced by yet another problem for the markets. These problems are what cause prices to change and create opportunity for traders.

Softs are commodities like sugar, cocoa, coffee, orange juice, cotton and lumber. Most of these have low volume and are not usually traded by smaller traders. However, they are commodity products that we use every day of our lives and that means that the fundamentals of supply/demand still impact these products as well.

Sugar is one of the few commodities that grows in both hemispheres simultaneously. There is sugar cane and sugar beets, depending on the region of the world you are in.

The largest producer and exporter of cocoa is the Ivory Coast of Africa. Frequently, civil wars in that region have impacted the price of cocoa. There have also been many times when a labor strike caused price to rally. This emphasizes how one primary production point can impact prices and increase risk.

Coffee is a product of mostly South America and Vietnam but is grown in other areas of the world as well. The winter months of the northern hemisphere are the highest demand times for this product.

There are many different futures markets to trade and, with micro e-mini futures contracts available as well, futures are accessible to traders with smaller account sizes. As always when trading, it is important to diversify your portfolio. Traders should choose futures contracts based on their goals while considering the seasonal, geo-political, economic and other factors that affect each market.  There are plenty of Futures markets to trade that will allow a trader to diversify their portfolio and hedge against adverse moves that may occur in one or another Futures asset.

About the Author
Don Dawson

Don Dawson has been trading the futures markets since 1987. His perseverance through the ups and downs of trading, openness to the experience of others, balanced tolerance for risk and patience to wait for his setups are a few of his strengths as a trader. His teaching method has been referred to as "down to earth". He understands the student's need for a structured environment in the early stages of their trading education. As an Instructor, he uses humor to convey information in an accessible way.


This content is intended to provide educational information only. This information should not be construed as individual or customized legal, tax, financial or investment services. As each individual's situation is unique, a qualified professional should be consulted before making legal, tax, financial and investment decisions.

The educational information provided in this article does not comprise any course or a part of any course that may be used as an educational credit for any certification purpose and will not prepare any User to be accredited for any licenses in any industry and will not prepare any User to get a job. Past results are not a guaranty of future performance.

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