Futures contracts, also known as futures, are versatile financial instruments that allow investors to speculate on future price changes of underlying assets. Their popularity stems from the potential for high profits, flexibility, and the ability to hedge against market risks. With this guide, you will learn what futures contracts are, the benefits they can offer investors, the risks they carry, and how to trade them effectively.
What are futures contracts?
Futures contracts are agreements between two parties—the buyer and the seller—obligating them to exchange a specified quantity of underlying assets at a predetermined price on a future date. They are part of a broader group of derivative instruments, and their value depends on the prices of underlying assets, such as stocks, stock indices, currencies, commodities, or cryptocurrencies.
Key features of futures contracts
- Obligation to fulfill: Both the buyer and the seller are obligated to fulfill the agreement, which differentiates futures contracts from options.
- Standardization: All futures contracts are standardized, meaning their parameters, such as size, expiration date, and settlement method, are pre-defined by the exchange.
- Settlement: Futures can be settled physically, where the underlying assets are actually delivered, or in cash, where the difference between the contract price and the underlying asset price is settled monetarily.
- Leverage: Requiring only a fraction of the contract’s value (margin deposit) makes futures attractive to investors with limited capital.
How do futures contracts work?
Futures contracts rely on speculation about future prices of underlying assets. For instance, if you anticipate that the price of Bitcoin will rise, you can buy a futures contract on BTC. If your prediction proves correct, you will earn the difference between the contract price and the current asset price at the time of expiration or position closure.
Example of how futures contracts work
Let’s consider an example of a Bitcoin (BTC) futures contract:
- You buy a BTC futures contract at $50,000, anticipating a price increase.
- You pay a margin deposit, e.g., 10% of the contract value, which in this case amounts to $5,000.
- The price of Bitcoin rises to $55,000, so your profit is the price difference multiplied by the contract size ($5,000 per unit of BTC).
- You can close your position before expiration or wait for settlement.
Margin deposit and margin call
The margin deposit is an essential element of futures trading. It is the amount you need to deposit to open a position, securing the exchange against losses resulting from adverse price movements.
If the contract price moves against your position, a margin call may be issued to replenish the deposit. If additional funds are not provided, the position may be automatically closed.
Why invest in futures contracts?
Futures contracts offer numerous benefits to both speculators and investors seeking hedging opportunities. Here are some reasons to consider trading futures:
Speculation on market volatility
The price volatility of underlying assets creates opportunities to generate profits in futures markets. You can trade on both price increases and decreases by taking long or short positions, respectively.
Example:
If you believe that the price of Bitcoin will fall, you sell a futures contract (short position). If the price does indeed fall, you buy back the contract at a lower price, realizing a profit.
Leverage and effective capital management
Leverage allows you to control larger positions than your initial capital. For example, using 10x leverage, you can open a position worth $100,000 with only $10,000 in capital.
Advantages:
- The ability to achieve higher profits with less capital.
- Better utilization of available funds.
Risk:
- Leverage also increases potential losses, which requires careful position management.
Hedging an investment portfolio
Futures can serve as a hedging tool, allowing you to protect your portfolio against unfavorable price movements. For instance, if you hold a large stock portfolio, you can hedge against market declines by selling futures contracts on the appropriate stock index.
Liquidity and accessibility
Futures markets are typically very liquid, meaning you can easily open and close positions. Most exchanges offer access to a wide range of futures contracts on various assets.
Types of futures contracts
Futures markets offer a variety of contracts that can be tailored to individual investment goals. Here are the most popular types:
Perpetual contracts
Perpetual contracts, also known as perpetual futures, are particularly popular in cryptocurrency markets. They have no set expiration date, meaning you can maintain a position as long as you have sufficient margin.
Fixed-term contracts
This type of contract specifies an exact expiration date, after which the contract is settled. They are common in traditional financial markets, such as commodity exchanges.
Futures contracts on various assets
- Commodities: include raw materials like crude oil, gold, or grains.
- Currencies: futures on currency pairs, e.g., EUR/USD.
- Cryptocurrencies: contracts on Bitcoin, Ethereum, and other digital assets.
- Stock indices: futures on indices like the S&P500 or WIG20.
How to start trading futures contracts
Choose an investment platform that offers a wide range of futures contracts and low transaction fees. For example, Binance is one of the most popular exchanges for cryptocurrency futures contracts.
Account opening process
- Registration: Create an account on your chosen platform.
- Identity verification: Required by most regulated exchanges.
- Deposit funds: Fund your investment account using cryptocurrencies or fiat currencies.
Opening positions on futures contracts
- Select the underlying instrument, e.g., BTC/USDT.
- Set transaction parameters: number of contracts, leverage level, stop loss, and take profit orders.
- Confirm the transaction and monitor your position.
Advantages and disadvantages of trading futures contracts
Advantages:
- Versatility: the ability to speculate on both price increases and decreases.
- Leverage: better utilization of capital.
- Wide range of instruments: futures available on various assets.
- Hedging: protection against market risk.
Disadvantages:
- High risk: the possibility of rapid losses in the event of improper risk management.
- Complexity: futures contracts require advanced knowledge.
- Fees and costs: transaction costs, position maintenance fees, and other expenses can reduce profits.
Five examples of cryptocurrency futures contracts
Trading cryptocurrency futures is becoming increasingly popular among investors seeking new opportunities for speculation and portfolio hedging. Here are five detailed examples of futures contracts on various cryptocurrencies, their features, and potential uses.
1. Bitcoin Futures (BTC/USD)
Bitcoin is the oldest and most recognizable cryptocurrency, which is why BTC futures are highly sought after. These contracts allow investors to speculate on Bitcoin’s future price on traditional exchanges, such as CME Group, as well as cryptocurrency platforms like Binance Futures.
Key features:
- Underlying instrument: Bitcoin (BTC)
- Standardization: On CME, each futures contract represents 5 BTC, making it more suitable for institutional investors.
- Leverage: Cryptocurrency exchanges like Binance offer leverage up to 125x.
- Settlement: Cash settlement or physical delivery (actual delivery of BTC) is possible.
- Funding mechanism: For perpetual contracts on crypto platforms, funding rates keep futures prices aligned with the spot market.
Example use case:
An investor anticipates Bitcoin’s price rising from $50,000 to $55,000 within a month. They purchase a BTC/USD futures contract with 10x leverage. If the price reaches the expected level, the profit from the transaction will be significantly greater than trading without leverage.
2. Ethereum Futures (ETH/USD)
Ethereum is the second-largest cryptocurrency globally, known for its functionality in smart contracts and decentralized applications (dApps). ETH futures allow traders to speculate on its price volatility or hedge their long-term positions.
Key features:
- Underlying instrument: Ethereum (ETH)
- Standardization: On CME, ETH futures contracts represent 50 ETH.
- Leverage: Binance Futures offers leverage up to 100x on ETH/USDT contracts.
- Settlement: Mainly cash settlement.
- Popularity: ETH futures are especially popular during significant events in the Ethereum ecosystem, such as network upgrades.
Example use case:
A trader expects Ethereum’s price to rise from $3,500 to $4,000 before a new network upgrade. They purchase an ETH futures contract with a low margin requirement and high leverage. If their prediction proves correct, they can achieve a significant profit, but failure to meet expectations carries the risk of losing the margin.
3. Binance Coin Futures (BNB/USDT)
Binance Coin (BNB) is the native token of the Binance exchange, used for reducing transaction fees and as an underlying asset for various products in the Binance ecosystem. BNB futures allow traders to take positions on the rise or fall of the token’s value.
Key features:
- Underlying instrument: Binance Coin (BNB)
- Leverage: up to 50x on Binance Futures
- Volume: Due to Binance’s popularity, BNB futures are among the most liquid instruments.
- Settlement: Cash-settled (USDT)
- Uniqueness: BNB’s value often depends on the activity of the Binance exchange and its users.
Example use case:
An investor predicts that the upcoming quarter will bring increased activity on Binance, leading to a rise in BNB’s price. They purchase a BNB futures contract and use leverage to amplify potential gains.
4. Solana Futures (SOL/USDT)
Solana (SOL) is a blockchain platform known for its high throughput and low latency. With its rapid rise in popularity, Solana has become one of the main assets for futures trading.
Key features:
- Underlying instrument: Solana (SOL)
- Leverage: up to 50x on cryptocurrency exchanges
- Volatility: SOL is characterized by high volatility, creating opportunities for speculators.
- Settlement: Cash-settled in stablecoins, e.g., USDT USDT
- Use case: Solana futures are attractive to investors speculating on short-term volatility.
Example use case:
A trader notices that Solana has announced new partnerships with major tech companies. Anticipating a rise in SOL’s price, they buy futures contracts. Quick price increases in the token allow for substantial profits, but incorrect assumptions can lead to losses.
5. Cardano Futures (ADA/USDT)
Cardano (ADA) is a blockchain platform that emphasizes a scientific approach to development. ADA futures attract both speculators and long-term investors seeking hedging opportunities.
Key features:
- Underlying instrument: Cardano (ADA)
- Leverage: up to 20x on most cryptocurrency exchanges
- Settlement: Cash-settled
- Popularity: ADA futures gain prominence during network development announcements.
Example use case:
An investor wants to hedge their ADA position against potential price declines. They sell ADA futures contracts, which, in case of a price drop, help offset losses in their spot portfolio.
Summary
Trading futures contracts is a powerful investment tool that can bring significant profits but also entails substantial risks. Understanding how futures work, the risks involved, and applying appropriate risk management strategies is essential. If you are ready to explore the futures market, remember to choose a trusted platform, such as our Bitcoin Quark exchange, which offers security, transaction speed, and the lowest fees on the market.
FAQ
What are futures contracts?
Futures contracts are agreements that obligate the buyer and seller to exchange underlying assets at a set price on a specific date in the future.
How does leverage work in futures contracts?
Leverage allows you to control larger positions with smaller capital. It increases potential profits but also the risk of losses.
What are the main risks of trading futures contracts?
The main risks include the potential for rapid capital loss, risks associated with leverage, and the complexity of the instrument.
Are futures contracts suitable for beginners?
Futures contracts are an advanced investment instrument and may not be suitable for beginner investors. It is advisable to first gain knowledge and experience.
Where can you trade futures contracts?
Futures contracts can be traded on traditional exchanges like CME and cryptocurrency platforms like Binance. You can indirectly connect by purchasing Bitcoin through the Bitcoin Quark exchange.
