Module 1: Introduction to Futures Contracts

Objective: Understand what futures contracts are, how they work, and why they are essential for traders and businesses.

Welcome to the exciting world of futures trading! In this first module, we’ll break down the basics of futures contracts, explore their purpose, and show you why they’re a powerful tool in financial markets. Whether you’re a beginner or brushing up on the fundamentals, this module will give you a solid foundation to build on. Let’s dive in!

---

What is a Futures Contract?

A futures contract is a standardized agreement between two parties to buy or sell an asset at a specific price on a set future date. Think of it as a handshake deal with clear rules, traded on regulated exchanges like the Chicago Mercantile Exchange (CME).

Key Components of a Futures Contract

1. Underlying Asset: The item being traded, such as commodities (e.g., wheat, oil), financial instruments (e.g., stock indices), or even cryptocurrencies.

2. Contract Size: The quantity of the asset (e.g., 5,000 bushels of wheat or 1,000 barrels of crude oil).

3. Expiration Date: The date when the contract must be settled.

4. Price: The agreed-upon price for the asset, fixed at the time of the contract.

Example: Imagine a farmer and a bakery agree in March to trade 5,000 bushels of wheat in September at $7 per bushel. This is a futures contract. If wheat prices rise to $8 by September, the bakery benefits by buying cheaper; if prices drop to $6, the farmer is protected from the loss.

---

Why Trade Futures?

Futures contracts serve two primary purposes: hedging and speculation. They’re used by a wide range of players, from farmers to Wall Street traders. Here’s why they matter:

1. Hedging

Hedging is like buying insurance against price changes. Businesses use futures to lock in prices and reduce uncertainty.

- Example: An airline buys crude oil futures to secure fuel prices for next year, protecting against sudden spikes.

- Who Uses It?: Farmers, manufacturers, energy companies, and portfolio managers.

2. Speculation

Speculators aim to profit from price movements without intending to take delivery of the asset.

- Example: A trader buys gold futures at $1,800 per ounce, expecting prices to hit $1,900. If prices rise, they sell the contract for a profit.

- Who Uses It?: Retail traders, hedge funds, and day traders.

3. Liquidity

Futures markets are highly liquid, meaning you can easily buy or sell contracts. Major markets like the S&P 500 or crude oil futures see billions in daily trading volume.

4. Leverage

Futures allow you to control large positions with a small amount of capital, thanks to margin (more on this in Module 2). While this amplifies potential profits, it also increases risk.

- MikoFutures Tip: Leverage is a double-edged sword—use it wisely with strict risk management.

---

History of Futures Markets

Futures trading has deep roots:

- 1848: The Chicago Board of Trade (CBOT) was founded, creating a marketplace for farmers and buyers to trade grain futures.

- 19th Century: Agricultural futures dominated, helping stabilize food supply chains.

- 20th Century: Markets expanded to include metals, energy, and financials (e.g., stock indices, currencies).

- Today: Futures cover everything from Bitcoin to weather derivatives, with global exchanges like CME, ICE, and Eurex leading the way.

Understanding this history shows how futures evolved from practical tools for farmers to sophisticated instruments for modern finance.

---

Futures in Action: A Real-World Scenario

Let’s see how futures work in practice:

- Scenario: A coffee shop chain wants to secure coffee bean prices for 2026. In January 2025, they buy coffee futures contracts for 37,500 pounds (one standard contract) at $1.50 per pound, expiring in December 2025.

- Outcome 1 (Price Rises): By December, coffee prices jump to $2.00 per pound. The chain buys at $1.50, saving $0.50 per pound ($18,750 per contract).

- Outcome 2 (Price Falls): Prices drop to $1.20. The chain pays $1.50, costing more, but their budget is predictable.

- Speculator’s View: A trader who bought the same contract at $1.50 and sold at $2.00 makes an $18,750 profit without ever touching coffee beans.

This dual role—hedging for stability, speculating for profit—makes futures unique.

---

Quiz: Test Your Knowledge

1. What is a futures contract?

a) A loan to buy assets

b) An agreement to trade an asset at a future date

c) Ownership of a company’s stock

Answer: b

2. What’s the main difference between hedging and speculation?

a) Hedging seeks profit; speculation reduces risk

b) Hedging reduces risk; speculation seeks profit

c) Both aim for profit only

Answer: b

3. Which of the following is a common underlying asset for futures contracts?

a) Real estate

b) Commodities

c) Bonds

Answer: b

4. What is the role of a clearinghouse in futures trading?

a) Sets the price of futures contracts

b) Ensures both parties fulfill their obligations

c) Manages the marketing of futures

Answer: b

5. What does the term "margin" refer to in futures trading?

a) The profit made on a trade

b) The deposit required to open a futures position

c) The difference between bid and ask prices

Answer: b

6. Which type of trader uses futures to protect against price fluctuations?

a) Speculator

b) Hedger

c) Arbitrageur

Answer: b

7. What happens if a futures contract is held until its expiration date?

a) It is automatically renewed

b) The contract is settled or delivered

c) The contract becomes void

Answer: b

8. What is the primary purpose of leverage in futures trading?

a) To reduce transaction fees

b) To control a large contract value with a small investment

c) To guarantee profits

Answer: b

9. Which of the following is NOT a characteristic of futures contracts?

a) Standardized terms

b) Traded on exchanges

c) Unlimited contract sizes

Answer: c

10. What is a "mark-to-market" process in futures trading?

a) Setting the initial contract price

b) Daily adjustment of margin accounts based on price changes

c) Finalizing the contract at expiration

Answer: b

---

Exercise: Apply What You’ve Learned

Task: Identify one real-world scenario where a business or individual might use a futures contract. Write a brief description (2-3 sentences).

Example: A jewelry company buys gold futures to lock in prices for next year’s inventory, protecting against rising gold costs. This ensures stable production costs and predictable pricing for customers.

Submit: Share your scenario in the MikoFutures community Discord or email it to support@mikofutures.com for feedback!

---

Key Takeaways

- A futures contract is a standardized agreement to buy or sell an asset at a set price on a future date.

- Futures are used for hedging (reducing risk) and speculation (profiting from price changes).

- They offer liquidity and leverage, making them attractive but risky.

- Futures markets have a rich history, evolving from agriculture to global finance.

---

What’s Next?

In Module 2: How Futures Markets Work, we’ll explore the mechanics of futures exchanges, the role of clearinghouses, and how margin works. Get ready to dive deeper into the nuts and bolts of trading!

Ready to Continue? Jump to Module 2 or join our community for exclusive tips and Q&A sessions.

Stay Connected: Follow MikoFutures on 𝕏 for market updates and trading insights.