Online Futures Trading

Generally speaking, a futures contract represents an agreement to buy (or sell) a commodity at a pre-defined price on a pre-defined date.

Commonly, futures are available in these following flavours: (These flavours are defined by the underlying “cash” product)

Stock Index Futures – One can’t really buy an index, so, these are settled in cash using some kind of correlation.
Commodity Futures – Taking as an example the Gold futures contract, it gives you the right to buy or sell a quantity of Gold at a pre-defined price in the future.
Interest Rate Futures (These include Bill Futures, Deposit Futures, and Government Bond Futures) – As well as others, they are typically settled in cash.

Future contracts were created to allow people that want more risk to take it from people that want less. Technically it’s called risk transfer.

How is this done? Well, using several features like:
* Liquidity
* Leverage (a smaller amount of money is deposited as a margin for a larger amount of money)
* High correlation degree between the changes in the underlying instrument and the changes in the futures price. Usually this is ensured with the mechanism of basis trading. In the commodity futures case, if one sells a commodity future he’s promising to deliver “N” amount of this commodity at a certain price (now fixed) at a pre-defined date.

All this means that if the futures price becomes too high in relation to the price of the commodity these days, you can borrow money and buy the commodity just now, and then sell a futures contract for it (on margin). If the difference in price between the two is big enough, then you’ll be able to pay the loan and the interest and still have some risk less profit. Pure arbitrage I should say.

On the other hand, if the futures price falls far below from the commodity price, then you can short-sell the commodity and buy the future.

You can borrow the commodity until the date of delivery for the future (bonds are a good example of this borrowing), and then cover your short position when taking deliverance of some of the commodity at the predefined date.

Both these two arbitrage trades are well known as “basis trades”, because you are trading the “basis” between the futures contract and the underlying “cash product”.

Futures are derivative products and should only be used by well experienced traders.