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Financial Futures - Definition
Financial Futures are futures contracts written on financial securities such as stocks, index and forex.
Financial Futures - Introduction
Financial Futures, also known as Futures on Financial Investments, are one of the most important innovations in the financial world today. Financial futures allow non-physical assets which cannot be traded on its own, such as an index, to become tradable for the purpose of hedging or speculation. Financial futures also provide leverage so that financial assets that are too expensive to trade the actual asset becomes accessible to traders with small fund size.
This tutorial shall explore what Financial Futures are, the different kinds of Financial Futures and how you can profit from them.
What are Financial Futures?
Futures contracts are originally created for the trading of physical agricultural products such as rice since ancient times. Even the modern futures market that we see today started with Commodity Futures. Financial futures are a relatively recent innovation created for the trading of non-physical financial investments such as interest rates and shares (shares are non-physical in the sense that publicly traded shares now come in the form of an electronic record rather than real physical share certificates). While modern commodity futures has been around since the 1800s, financial futures only came into being since the 1970s starting with Forex Futures.
Types of Financial Futures
The term "Financial Futures" does not refer to a specific kind of futures contract but is instead the name for a broad category of futures contracts written on financial securities. There are four main classes of Financial Futures; Forex Futures, Interest Rate Futures, Index Futures and Single Stock Futures. Under each class of Financial Futures, there are multiple markets and contracts making "Financial Futures" truly a huge family of futures contracts.
How To Trade Financial Futures?
In order to trade Financial Futures, you must first choose the specific Financial futures market that you wish to trade in. As you can see above, there are many different financial futures markets and the behavior and specific strategies for each market may also be different. Selecting a specific financial futures market to trade in depends largely on your area of knowledge and expertise. If you are knowledgable in forex, then the forex futures market may be your most suitable financial futures to trade in. Once you have determined the specific financial futures market to be involved in, it is simply a matter of opening a futures trading account and then going through the steps in trading futures.
Types of Financial Futures
As you can see from the picture above, there are four main types of financial futures; Forex Futures, Interest Rate Futures, Index Futures and Single Stock Futures. All financial futures fall under one of these four classes and under each class, there are many different specific futures markets so lets take a look at each of these classes.
Forex Futures, short form for Foreign Exchange Futures and also known as Currency Futures, are the first financial futures that was ever created. Created at the end of the Bretton Woods currency system, Forex Futures created a global market in which currencies from around the world may be traded and hedged against in order to create the kind of stable, price discovery market for currencies the way futures contract has done for commodity futures long before the creation of financial futures. Forex futures allows futures traders to speculate on currency trends and also allow for hedging against forex risk in international business.
Learn more about Forex Futures.
Interest Rate Futures
Interest Rate Futures are futures contracts offered on interest bearing instruments such as treasuries. These are mainly used by corporations hedging against interest rate risks when borrowing from banks. Interest Rate Futures market isn't a popular speculative market and are usually used by professional futures traders who speculate on the term structure of interest rates using multi-legged futures spreads.
Index futures are one of the most important form of financial derivatives instrument in the world today. Index futures allow indices, which are nothing more than numbers reflecting market trend, to be traded for speculative hedging purpose. With index futures, investors can now hedge a market equities portfolio simply by going short on futures contracts on the specific index best representing their portfolio. Index futures also allow investors to speculate on the overall trend of a market without having to buy up all the stocks making up an index in the correct proportion. Some of the most famous index futures include the S&P500 e-mini as well as the Nikkei225 Futures.
Learn more about Index Futures.
Single Stock Futures
Single Stock Futures, or SSF, is the youngest of the financial futures family. As the name suggests, Single Stock Futures are futures contracts offered on publicly traded stocks. For many years, regulation has resisted the idea of having futures contracts made available for stocks as they felt that it could lead to manipulation of stock prices. However, over the decades, futures has proven itself to be an extremely valuable price discovery instrument and in a heavily liquid environment, it is nearly impossible to lead to manipulation. As such, SSFs made its start on some of the most heavily traded stocks in the US market and is now offered on a large number of stocks. Single Stock Futures also made it possible for complex trading strategies involving stocks, futures and options to be traded as Single Stock Futures are based on 100 shares per contract just like stock options.
Learn more about Single Stock Futures.
General Characteristics of Financial Futures
Financial futures are extremely diverse and each kind of financial futures have their own trading characteristics and behavior. Financial futures are usually cash settled futures without any physical delivery upon maturity. This means that upon expiration, the long and short settle their wins and losses in cash without the need to actually trade the underlying. However, with the exception of index futures, almost all other kinds of financial futures has offered physically settled versions. Index futures can never be physically settled due to the fact that an index is simply a number and not made up of any physical assets.
Financial futures generally display an inverted market term structure due to the fact that financial futures such as index futures have only the foregone interest rate on cash as opportunity cost without any of the complicated storage and ownership cost of commodity futures. This makes it hard to produce a roll yield when rolling forward a financial futures position. However, single stock futures do sometimes display normal market characteristics.