In the world of finance, there are different types of investment vehicles including equities, futures, options, forwards and others. Most people are familiar with the equity markets, but the futures space can at first glance appear to be mysterious. Each investment vehicle comes with its own set of risks and rewards which I will attempt to explain in a simple way.
When you typically invest in a company, through the equity markets, you are actually buying a piece of it through a share. The value of a company that is traded on the stock market, is calculated by multiplying the total number of shares by the present share price. This is what is also known as the market capitalization of the company. Typically investors in the equity domain monitor fundamentals and assess value of the company based on company financials and growth strategies.
With futures, you are not investing in a corporation, but rather are buying a contract to have exposure to an asset. A futures contract allows an investor to speculate on the direction of a security, commodity, or financial instrument. Some examples include commodities such as corn, stock indices, weather, and more recently cryptocurrency. The futures contract have different expiration dates so you can set long and short term expectations.
To recap, futures markets provide a means for trading the price of a commodity at some point in the future. The shape of this series of prices is known as the futures curve. The contracts have expiration dates so that long and short term prices can be gauged. The example below shows the an example of VIX futures based off of the VIX index.
“VIX is the ticker symbol and the popular name for the Chicago Board Options Exchange’s CBOE Volatility Index, a popular measure of the stock market’s expectation of volatility based on S&P 500 index options. It is calculated and disseminated on a real-time basis by the CBOE, and is often referred to as the fear index or fear gauge.”
This future’s curve below for the VIX implies that people expect that there will be more volatility in the long term over the short. Contango occurs when expiration futures are HIGHER than the price of the near term expiration futures. Most futures are typically in Contango.
Overall, futures markets involve a significant amount of speculation. For many, investing in futures is a good way to diversify into a new asset class and augment your investment portfolio.
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