But futures trading hasn’t always been a ready-made, ‘part-of-the-furniture’ investment.  In fact, futures have developed over a long period of history as devices for security of trade and as a means to quickly raise cash from existing assets, and their back-story is one that can be traced for thousands of years to the ancient civilisations of Rome and China, and even earlier in a less sophisticated form.

One of the earliest references to futures trading that has been discovered dates from Babylonian times, and takes the form of livestock-shaped tokens, discovered alongside dates promised and actual for delivery.  While obviously a highly simplified version of the futures contract, these agreements to trade assets at a specified future point were the beginnings of the futures derivative we know and trade today.

The Chinese civilisations dating back to 4000BC were also involved in trading futures on rice, through the mechanism of rice tickets.  These devices were designed to allow rice traders to generate money ahead of the harvest and to guarantee ongoing revenue. Even at this early stage, specifics were drawn into these agreements, such as a specific date, quantity and quality of rice to be traded.

It has also been demonstrated that early major global civilisations were engaged in international trade thanks to the forerunners to futures contracts.  The Romans were found to have traded for Lebanese lumber, Chinese silk and other Asian spices off the back of futures contracts, thereby introducing extremely valuable commodities to the Roman domestic market.

In more comparatively recent times, the Knights Templar established informal futures contracts for the delivery of goods from European merchants, acting as agents for the buying and selling of commodities across Europe.  While not written or formalised, these agreements were thought to work on trust and honour that delivery would be made at a future point in time, with the Knights Templar serving to manage disputes between trading merchants.

In modern times, futures have grown to embrace the technological revolution of trading and markets, and are today a hi-tech, constantly traded virtual instrument.

The story of futures trading is one that is littered with twists and turns, and the humble futures contract has come a long way from the days of stone tokens and etchings on the side of rocks.  While futures contracts have grown to become highly sophisticated trading instruments with an automatic reaction to underlying price and a wholly automated sale process, they nevertheless find their roots in the ingenuity of ancient civilisations.

At the start of their lifespan, futures contracts were little more than verbal or symbolic agreements, designed to allow traders to generate an immediate return on future delivery of commodities.  This was particularly useful for farmers and merchants throughout the early to middle ages, and even as late as the 20^th century futures were used in personalised trading (as opposed to exchange trading) to provide the same cash flow benefits.

The ability to hedge against future manufacturing costs also made futures an attractive option for manufacturing and secondary sector businesses.  Bread manufacturers, for example, used futures to guarantee the future cost of wheat to keep a lid of the costs of production, while car manufacturers turned to steel futures in an attempt to curb the rising costs of raw materials.

While today this is still a predominant feature of futures trading, the advent of cash-settled futures has opened up the market to a wider array of speculators and investors with no direct interest in the underlying asset – rather, their main concern is with the ability to speculate on asset prices over the medium to long term.

Perhaps the most significant changes to trading futures have arisen over the last 30 years or so, with the development of automatic, electronic trading and the widespread uptake of the Internet as a platform for remote trading.  As the global exchanges began to investigate the merits of moving away from physical trading systems to virtual platforms, so too did the trading experience become much more streamlined and ultimately more profitable as a result of the reduced transaction costs afforded by technology.

With the rise of the Internet and the wild growth of online brokerage platforms, futures have also now been opened to a mass-market audience, and more private individuals are getting involved in trading than ever before thanks to the ease with which anyone can setup an online trading account.  Over such a short space of time, the Internet has revolutionised the trading environment forever, and the future direction of futures trading, not to mention other derivatives, is something of keen academic and practical interest for those involved.

The development of futures contracts over the centuries has been marked, but none more so than the growth and evolution of futures over the 21^st century.  As computer technology becomes an even more integral part of our daily lives, the whole trading outlook for futures has been radically altered to make it much easier and more intuitive process.  As the electronic dimension continues to expand, so too will futures become more refined and more streamlined as an instrument, which could pave untold opportunities for investors over time.

From their early adoption in the ancient global civilisations as a tool for merchants and farmers, futures have grown to become a massive international business, with investment funds and private investors diversifying their existing portfolios to spread the risk of wayward investments.  Over the last 20 years, the leaps forward in technology have allowed futures to blossom into a popular trading instrument, with the advent of exchanges and live markets making futures trading a feasible option for both fund managers and consumer traders, and as technologies continue to develop and progress there is no doubt futures will continue this path of development.

But what does the future hold for futures? What possible innovations lie ahead with futures, and how will the markets respond to meet the demands of futures traders going forward?  The answers almost certainly lie in technology, and in the integration of new trading methods and triggers.  In recent years we’ve seen the development of sophisticated trading bots, which will continue to improve in their efficiency and effectiveness when it comes to spotting profitable trades.

Similarly, as trading platforms and exchanged grow to facilitate even faster, even more intuitive trading, it is foreseeable that the futures market will open even further to a consumer investor demographic, which will yield benefits both in terms of market liquidity and also for the futures brokerage industry.

Likewise, as natural commodities run increasingly scarce over the course of the next century, the value of futures contracts will be significantly enhanced.

Commodity futures are widely traded on futures exchanges, quoting a price point at which traders can secure a future purchase (or sale) of the specified commodity.  For long positions, futures on commodities can be traded before the date of maturity to realise a profit (or indeed a smaller loss) on the value of the futures without having to settle the position.  It is critical to bear in mind that unlike options, futures are an obligation to buy a certain quantity at a certain period, so for that reason it is essential to cost in the impact of having to settle a heavily losing position, in addition to absorbing the loss in value of futures.

While you won’t ever have to take stock of that 1,000 bushels of wheat order you’ve placed, it’s nevertheless worthwhile calculating the risks of price movements against your position, in addition to the decay in the value of your futures that can be expected over time in order to fully appreciate the risks involved, and it is thoroughly recommended that you set guaranteed stop losses at all times to make sure you don’t lose too much on one misjudged investment.

That said, futures on commodities do have a number of key advantages over trading directly in the raw materials to which they relate.  Primarily, the lower cost barrier to entry makes it possible for even small-capital investors to generate a return from commodities.  No warehousing costs, no freight, no resale problems – it’s all handled as a cash transaction through an exchange where you don’t ever come close to seeing the product you are obliged to one day own.

Of course, with this advantage comes the natural corollary of leverage.  Because your investment is in the future right to buy commodity X, you can effectively invest in tens of thousands worth of your chosen commodity for just a fractional margin deposit.  This means you can reap the rewards of small price movements amplified across larger transaction sizes, without having to down-pay the initial capital sum.

Suppose a trader identifies a positive trend in wheat pricing, and seeks to take a long position on wheat to capitalise on what he anticipates as near future rises in wheat prices.  Fortunately, the trader makes the correct decision to invest, and wheat prices rise by 10% over the following six months.

At $10 a bushel, a $100 deposit could buy 10 bushels, excluding the cost of facilitating the trade and handling the raw commodity.  After six months, the trader could then sell his wheat at a rate of $11 a bushel (the new increased market value), to yield a gross 10% return on his investment.

But had the trader invested in wheat futures, the outlook could have been altogether different.  At a leverage of even 50:1, the same $100 capital could have afforded $5000 worth of wheat, equivalent to 500 bushels.  As a cash-settled transaction, there’s no need to take stock of any product, but it is still possible for the trader to cash in on the rise in pricing.  At the end of the six months period to which his futures contracts relate, the trader could either settle the transaction at a value of $5,500, leaving a $500 trading profit, or close out the position early to lock in a slightly lesser profit amount.  When compared with the $10 gross gains achievable through direct investment, the $500 afforded by trading futures in exactly the same conditions on the precisely same asset starts to look like an attractive option.

Of course, this is an oversimplification of how futures work in practice, but it highlights the key advantages in trading commodities via futures rather than directly, and goes some way towards identifying the core reasons why investors and fund managers choose futures as their commodity investing tool of choice.

But the vast majority of currency trading is handled through the forex, rather than futures markets.  The forex markets are renowned for their leverage, and have given birth to more than their fair share of currency millionaires.  In spite of that, futures can pose a number of key advantages over trading directly on the forex exchanges, namely in terms of the cost-savings implications and the enhanced leverage options currency futures afford.

The primary reason traders take futures positions on currencies is to allow longer-term speculation on currency prices.  Forex trading is ideal for the day trader, looking to enter and exit positions in quick succession to bank a profit over the trading day.  But for those looking to speculate on a currency price three months, six months or even twelve months down the line, the financing costs with forex trading quickly become prohibitive.

Additionally, futures build in a comfort zone for a dip in pricing in between the date of purchase and the date of expiry.  A currency price can behave however it likes, so long as by the expiry date it has surpassed the price locked in on the day of purchase.  With straightforward forex trading, this isn’t necessarily an option, particularly as the costs of financing the leverage portion begin to bite.

If a trader takes a long position on the US dollar, it is possible to leverage through both forex trading and futures.  The key difference, however, lies in the nature of the transaction.  Even leveraged positions in forex actually acquire currency, whereas futures trading gives the trader the right to only the obligation in currency.  This means that while intermediate negative performance can be enough to wipe out the value of a leveraged forex position, it will not impact on the long-term value of the trade in futures, so long as the currency price recovers in time to meet the expiry date of the futures contract.

For example, envisage a trader investing his capital fund of $100 in pound sterling.  Assuming both the forex and futures transactions afford a leverage of 50:1, forex trading would notionally acquire $5000 worth of pounds sterling to play with, while the futures transaction would acquire $5000 worth of rights to buy pounds sterling.  This effectively means that the leverage on the futures trade is significantly amplified compared to the forex trade, in addition to allowing the long-term speculation on currency price over the lifespan of the futures contract.  The futures contract can either be closed at any profitable time, or executed on maturity to deliver an enhanced return for the currency trader.

One of the foremost functional benefits of trading futures as opposed to commodities or shares directly is the ability to buy in at a much lesser rate, thus demolishing the existing barriers to entry faced by many other traders.

Non-derivative trading requires the trader to stump up 100% of the transaction cost up-front, and all of that capital is invested in the underlying asset – an ‘eggs in one basket’ scenario.  With futures, that isn’t necessary, and traders can still enjoy the same rate of return on their investment for a considerable lesser margin.

Rather than stumping up the cash for a share purchase, or even a partial deposit on a leveraged share buy, traders are required only to foot a margin on the futures price, which is always lower than the value of the underlying asset, thus effectively allowing traders to amplify small transactions significantly in order to reap the rewards of price movements on a larger notional transaction.

The primary advantage of trading shares and securities with futures is the ability to leverage the transaction, afforded by the nature of futures as an instrument.  Because futures essentially stipulate a future transaction and have a primary value of their own, movements in the underlying asset price are amplified through the futures contract price, allowing traders to capitalise on small price movements to the same extent as they would with a pound for pound investment.

It is this leverage that makes futures the attractive and widespread instrument they are today.  Aside from the practical advantages of futures for hedging or locking in the costs of production as a manufacturing business, the ability to leverage and take long-term positions on assets for a lower capital investment has made futures a dynamic, pliable and ultimately popular instrument amongst traders at all stages.

Futures also provide the distinct advantage of saving on tax in the UK when it comes to trading shares.  A direct investment in and sale of shares gives rise to stamp duty and capital gains tax, whereas the investment and sale of futures contracts cuts out the stamp duty liability, providing not only the opportunity for a highly leveraged transaction but also a lower cost for traders to bear.

Futures contracts on shares are an increasingly popular, potentially lucrative alternative to share purchases.  While the underlying asset isn’t acquired until the date of maturity, and may in fact never be acquired by the trader who resells their futures contracts, the ability to leverage transactions while saving on the tax burden and minimising the risk of acquiring failing stocks makes futures an attractive investment opportunity for share traders.

Interest Rates

One of the core and most common types of index to be traded with futures contracts is interest rates.  Interest rates, as stipulated by the world’s central banks pose a significant threat to businesses that rely heavily on finance, and so it’s imperative for businesses to hedge against these risks by taking positions in interest rates futures.  Interest rates futures rely on instruments with an interest yield as the basis of the contract, and afford traders the ability to hedge against interest rate rises.  This creates a liquid market for the instruments, and allows traders to capitalise on their market and economic knowledge to forecast the likely movements in interest rates that will come to bear on the value of their futures.

While this is naturally a longer-term investment proposition, interest rates as a basis for futures investing is both a potentially lucrative trading market, in addition to one that performs a crucial function in allowing businesses to safeguard their interests with inversely correlated instruments.

Market Performance

Futures are also traded on markets as indices, for example the FTSE 100.  The effect of this type of futures contract is to give traders the ability to back (or sell) an overall economy, making use of macroeconomic triggers to determine when and how to trade.  Because the FTSE represents a collection of the UK’s 100 largest companies across different industries and sectors, it provides a reasonably accurate reflection over the medium term of the performance of a given economy.

While telecoms stocks might be performing poorly and a trader could lose out on futures in that sector while the remainder of the UK economy performs well, futures on the FTSE as a whole are likely to produce more reliable results, and results that can be more logically forecast in line with current affairs and government and central bank policy.

Futures can be traded on a virtually limitless base of assets, and wherever there is a practical need for the advantages futures contracts bring, it is likely that futures will be available to trade.

For the trader looking to make a significant return from his investment in futures, it is recommended that you narrow down the field of potential investments to hone in on one particular asset class in which you believe there are the biggest opportunities for earnings, or the more straightforward-to-interpret price behaviours – in being specialised, it becomes much more efficient and effective to trade futures contracts.

Abandon: The proceed of an asset holder in electing not to offset an option.

Accommodation trading: Uncompetitive kind of trading entered into by a trader.

Accumulate: Buy futures contracts in a great deal in a precise commodity at regular predetermined intervals.

Acreage Allotment: Government limitation on planted acreage of some basic crops.

Actuals: Physical products or cash commodities bought and sold on the spot market.

ADP: Alternative Delivery Procedure, a contract between a buyer and a seller by an agreement to resolve their delivery commitment independently of the exchange.

Aggregation: The theory under which all futures positions owned or controlled by one trader are joint to determine reporting status and fulfilment with speculative limits.

Allowances: The discounts (premiums) allowed the buyer for grades or locations of a commodity lower (higher) than the par (or basis) grade or location specified in the futures contract, also called differentials.

Annualize: To put on an annual basis (usually relates to interest rates).

Appreciation: An increase in the value of a market instrument.

Approved Delivery Facility: Any bank, stockyard, mill, storehouse, plant, elevator or other depository that is authorized by an exchange for the delivery of commodities tendered on futures contracts.

Arbitrage: The process of finding complimentary trading positions that guarantee a profit regardless of market movements. Usually, arbitraging occurs as a consequence of irregularities in the price of an asset across the futures and spot markets, and such opportunities are usually fleeting in nature.

Ask: The selling price of an asset or instrument – contrast with ‘bid’.

Assignable contract: A contract that allows the holder of an option to express his rights to a third party.

Assignment/Assignation: The legal process by which rights and obligations are transferred to another person. In the context of futures trading, commodities and underlying assets are usually assigned to the buying party within the warehouse, in order to prevent the significant costs of freight, insurance and handling.

At-The-Market: An order to buy or sell a futures contract at whatever price is obtainable when the order reaches the trading floor. Also called Market Order.

At-the-Money: When the exercise price of an option is the same as the current trading price of the underlying option, the latter is at-the-money.

Audit Trail: The record of trading information identifying, for example, the brokers participating in each transaction, the firms clearing the trade, the terms and time of the trade, and, ultimately, and when applicable, the customers involved.

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