Download the Schwab app from iTunes®Get the AppClose

What Are Futures and Why Trade Them?

The Schwab Guide to Futures Trading

World map representing international markets

Futures trading can help you tap into markets around the globe. This guide can help you understand what futures are and how you can make them part of your trading strategy.

Scroll down or choose a starting topic:

What is a futures contract?

The textbook answer is:
A futures contract is an agreement to buy or sell assets at a set date in the future for a set price.

Now let’s see what that really means with an example.

The country of Grease produces large quantities of oil.

Ride Airlines sells flights that require large quantities of oil.

At a market cost of $45/barrel:

Balanced scale representing profits from oil and flight sales

Grease is happy with profits from the oil it sells.

Balanced scale representing profits from oil and flight sales

Ride is happy with profits from the flights they sell.

If the price of oil rises to $55/barrel:

Scale tipping in favor of oil when prices are $55 per barrel

Grease’s profits grow by selling oil at a higher price.

Scale tipping in favor of oil when prices are $55 per barrel

Ride’s profits drop because they are paying more for oil.

If oil production rises dramatically and the price of oil drops to $35/barrel:

Scale tipping in favor of flights when oil prices drop to $35 per barrel

Grease’s profits drop by selling oil at a lower price.

Scale tipping in favor of flights when oil prices drop to $35 per barrel

Ride’s profits grow as cost of operation falls.

They both want to lock in the $45/barrel price because if it swings in either direction, one party’s profits will decrease. So they both meet with an investor who negotiates separate contracts.

Icon depicting contract between oil company and airline
Per Grease’s contract:

If the price of oil goes below $45, the investor keeps things level by paying the difference in lost profit to Grease.

Scale representing equilibrium reached for oil company when oil is $45 per barrel

If the price of oil rises above $45, Grease still receives $45/barrel and the investor keeps the additional profits.

Per Ride’s contract:

If the price of oil goes above $45, the investor keeps things level by paying the difference in lost profit to Ride.

Scale representing equilibrium reached for airline when oil is $45 per barrel

If the price of oil falls below $45, Ride still pays $45/barrel and the investor keeps the additional profits.

Both provider and supplier get stable pricing, and are managing their exposure to the risk of a price swing—also known as hedging.

Who trades futures contracts?

There are two types of futures traders: hedgers and speculators.

Hedgers use the futures market to manage price risk, like Grease and Ride.

Speculators use the futures markets to express their opinion on, and profit from, the direction of the market, much like an equities trader. They have no intention of taking or making delivery of the underlying asset.

Traders can speculate with futures contracts on a number of underlying assets, including:

Certificate icon

Equities Securities

Barrel of oil icon

Energies
(E.g. oil, gas, electricity)

Percentage sign icon

Interest Rates
(E.g. Eurodollar, 30-year bonds, Fed Funds)

Sliced orange icon

Commodities
(E.g. oranges, livestock, lumber)

Gold bars icon

Metals
(E.g. gold, silver, copper)

NASDAQ 100 icon

Stock Indexes
(E.g. S&P 500, NASDAQ 100, Nikkei 225)

Why should I trade futures?

There are several distinct benefits the futures market offers that the equities market does not.

Icon of desktop computer

Nearly 24-Hour Trading
Take advantage of global events at any time.

Icon of scale weighing certificate and money

Leverage
Instead of having to pay the full amount for a futures contract, futures traders are only required to post margin, typically set between 3-10% of the underlying contract value. This provides potential to generate larger returns, but also larger losses.

Icon of oil barrel

Diversification
You can trade futures on a variety of commodities (oil, corn, metals, beef, etc.) and financial instruments (commodities, currencies, interest rates, etc.).

Stopwatch icon

Short Selling
Get short exposure on the underlying asset by selling a futures contract as many times a day as you want.

Tax paperwork icon

Tax Benefits
Profits on futures trading are taxed on a 60/40 basis: 60% of profits are taxed as long-term capital gains, and 40% as short-term capital gains. Meanwhile, 100% of profits on stocks held less than a year are taxed as ordinary income.

How can I use what I know about trading equities to trade futures?

Starting with what you know about trading equities can be a good way to transition into futures trading.

Stack of gold bars icon

Decide on a category and an instrument within the category

“I’ve traded various metal companies for years, and am particularly knowledgeable about gold.”

Tip: This is similar to the Top-Down approach of selecting a stock.

Binoculars icon

Conduct fundamental and/or technical research

“I like how the RSI looks and the earnings announcement was promising.”

Tip: If you primarily use either technical or fundamental for stock research, you can stick with that strategy for futures.

Person with speech bubble icon

Form an opinion

“The price of gold is likely to rise from $1,275/oz to $1,350/oz in six to twelve months time.”

Tip: A simple starter strategy is going long to profit from a rising market with something like the E-Mini S&P.

Contact, calendar, and stopwatch icon

Evaluate available contracts by size and month

“I’m going to start small for this trade. And while six months isn’t long enough, twelve may be too long, I’m going for the nine month contract.”

Tip: The three most common contract sizes are standard, mini, and micro. Depending on the commodity, the contract month may be 30 days or well over a year away.

Exit sign icon

Set exit strategy (i.e. stop-losses and profit targets)

“I already know what I’ll do no matter which way the market moves.”

Tip: Using risk management tools like conditional orders can help you protect profits and limit losses.

Arrows in a circle icon

Execute your trade

“Here we go!”

Tip: Trade futures, equities, and options from the same trade ticket with Schwab’s platform, StreetSmart Central.

Piggy bank icon

Post initial margin

“I’ve got it covered.”

Tip: You need a minimum amount in your account at all times.

Adjustment sliders icon

Monitor and adjust your position

“I want to maximize my profits.”

Tip: Setting alerts can help you stay on top of your trade.

Important disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

There is no guarantee that execution of a stop order will be at or near the stop price.

Schwab does not recommend the use of technical analysis as a sole means of investment research.

©2018 Charles Schwab & Co., Inc. (Member SIPC) All rights reserved. (0818-8DYV)

Schwab has tools to help you mentally prepare for trading

Learn more >

Talk trading with a Schwab specialist anytime.
 
Call 888-245-6864
M-F, 8:30am - 9:00pm EST

Get 500 Commission-Free Online Equity and Options Trades for Two Years

Learn More >

(0818-8DVY)

Thumbs up / down votes are submitted voluntarily by readers and are not meant to suggest the future performance or suitability of any account type, product or service for any particular reader and may not be representative of the experience of other readers. When displayed, thumbs up / down vote counts represent whether people found the content helpful or not helpful and are not intended as a testimonial. Any written feedback or comments collected on this page will not be published. Charles Schwab & Co., Inc. may in its sole discretion re-set the vote count to zero, remove votes appearing to be generated by robots or scripts, or remove the modules used to collect feedback and votes.