What are Futures?
Billy Ray Valentine’s commodity lesson from Randolph Duke in the movie Trading Places:
“Now, what are commodities? Commodities are agricultural products…like coffee that you had for breakfast…wheat, which is used to make bread…pork bellies, which is used to make bacon…which you might find in a ‘bacon and lettuce and tomato’ sandwich.”
At that point Billy Ray (played by Eddie Murphy) takes an extended look into the camera…unimpressed by the condescending attitude.
“And then there are other commodities, like frozen orange juice…and GOLD. Though, of course, gold doesn’t grow on trees like oranges.” (after which Randolph chuckles)
That’s more or less futures in a nutshell.
Futures are financial instruments.
Stocks are financial instruments too.
Just like stocks give you the ability to buy or sell a company, futures let you buy or sell commodities. And as Randolph kindly helped with above, you’re already pretty familiar with commodities.
Here are some other examples:
Oil, Natural Gas, Silver, Platinum, Live Cattle, Cocoa, Sugar, Corn, Oats
and my favourite…Lean Hogs.
So, just like you might fancy the chances of the upcoming Facebook float (ie. its stock becoming publically traded), you might also think the current price of Lean Hogs is a steal.
Or…given the rising popularity of the Mexican dish ‘nachos’ (spawning from the movie Nacho Libre)…wonder how long Corn can last at these crazy prices.
The point being…no matter why you think Palladium is undervalued or Coffee just a little pricey, you can buy or sell these things and make money…if your suspicions about their value prove right. And futures (short for futures contracts) are what you use to get access to them.
So I bet you’re thinking…
How on earth could I know whether Lean Hogs are a good buy, or the price of Heating Oil is a little high?
Well…the price of futures is influenced by fundamental factors like the weather’s effect on supply (eg. a corn harvest) and the economy’s effect on demand (eg. the willingness of people to spend). So you can start studying that stuff if you like.
At KPI Capital we prefer to use charts (technical analysis) when trading futures….because broadly speaking it doesn’t matter if your chart gives you a buy signal on Bank of America or Random Length Lumber Futures…a buy is a buy.
PS. Futures also give you access to some of the biggest financial commodities in the world…like the S&P 500 stock index or US 30 Year Bonds.
PPS. Before you start trading futures it’s important to understand the particular contract’s specifications. Each futures contract is priced differently which can complicate the assessment of a trade’s risk. Plus, certain futures contracts are settled via physical delivery…that means if you’re left holding some on expiry…you might end up with a backyard full of cattle…
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