HOLLOW POINT TRADING
Understanding Futures Contracts
A futures contract is a legally binding agreement to buy or sell a specific asset at a predetermined price on a specific future date. Unlike buying stocks where you own a piece of a company immediately, futures contracts represent an obligation to complete a transaction at some point down the road.
These contracts are standardized and traded on regulated exchanges, which means every contract for the same product has identical specifications. This standardization creates deep liquidity and makes it easy for traders to enter and exit positions quickly.
🎯 Core Concepts
- Buyer (Long): Agrees to purchase the asset at the contract price when it expires
- Seller (Short): Agrees to deliver the asset at the contract price when it expires
- Settlement: Most retail traders close positions before expiration; physical delivery is rare
- Leverage: Control massive positions with a fraction of the contract value
- Two-way market: Profit from both rising AND falling prices
How Futures Markets Work
The Exchange System
Futures trade on centralized exchanges like the Chicago Mercantile Exchange (CME), Chicago Board of Trade (CBOT), and New York Mercantile Exchange (NYMEX). These exchanges act as intermediaries, guaranteeing that both sides of every trade fulfill their obligations.
When you place a futures trade, you're not trading directly with another person. Instead, the exchange's clearinghouse becomes the counterparty to every transaction, eliminating the risk that the other side won't honor the contract.
Margin: The Power of Leverage
One of the most important concepts in futures trading is margin. Unlike stocks where you might put up 50% of the purchase price, futures contracts require only a small percentage of the total contract value as a good-faith deposit.
Example: E-mini S&P 500 Futures
Let's say you want to trade one E-mini S&P 500 futures contract (ES):
| Metric | Value |
|---|---|
| S&P 500 Index Price | 5,000 |
| Contract Multiplier | $50 per point |
| Total Contract Value | $250,000 |
| Initial Margin Required | ~$12,000-15,000 |
| Effective Leverage | ~17x to 21x |
⚠️ Leverage Warning
Leverage magnifies both gains AND losses. A small adverse move can result in losses exceeding your initial margin. Always use proper risk management and understand that you can lose more than your initial deposit.
Daily Settlement (Mark-to-Market)
Futures positions are settled at the end of each trading day. This means profits and losses are calculated daily and credited or debited from your account. If your account falls below the maintenance margin level, you'll receive a margin call requiring you to deposit additional funds.
Types of Futures Contracts
Futures contracts exist for virtually every major asset class, giving traders exposure to markets around the world.
📈 Index Futures
ES E-mini S&P 500
NQ E-mini Nasdaq 100
YM E-mini Dow Jones
RTY E-mini Russell 2000
🛢️ Commodity Futures
CL Crude Oil
GC Gold
SI Silver
NG Natural Gas
💱 Currency Futures
6E Euro FX
6J Japanese Yen
6B British Pound
6A Australian Dollar
📊 Interest Rate Futures
ZB 30-Year Treasury
ZN 10-Year Treasury
ZF 5-Year Treasury
ZQ Fed Funds
Micro Futures: Accessible Entry Points
For traders who want smaller position sizes, micro futures contracts offer 1/10th the exposure of their standard E-mini counterparts. These are excellent for learning, practicing strategies with real money, or precise position sizing.
| Contract | Symbol | Point Value | Tick Value |
|---|---|---|---|
| Micro E-mini S&P 500 | MES | $5/point | $1.25 |
| Micro E-mini Nasdaq | MNQ | $2/point | $0.50 |
| Micro E-mini Dow | MYM | $0.50/point | $0.50 |
| Micro E-mini Russell | M2K | $5/point | $0.50 |
Futures vs. Stocks
Understanding the differences between futures and stocks helps traders choose the right instrument for their goals.
| Feature | Futures | Stocks |
|---|---|---|
| Trading Hours | Nearly 24 hours, 6 days/week | Regular: 9:30am-4pm ET |
| Leverage | High (5-20x typical) | Limited (2x margin accounts) |
| Short Selling | Equal ease as going long | Requires borrowing shares |
| Expiration | Yes, contracts expire | No expiration |
| Settlement | Daily mark-to-market | T+1 settlement |
| Tax Treatment | 60% long-term / 40% short-term | Based on holding period |
| Pattern Day Trader Rule | Does NOT apply | $25,000 minimum for PDT |
Trading Sessions
Futures trade nearly 24 hours a day, but not all hours are created equal.
| Session | Time (ET) | Characteristics |
|---|---|---|
| Globex Open | 6:00 PM Sunday | Week opens, can gap from Friday |
| Asia Session | 8 PM - 3 AM | Lower volume, smaller ranges |
| London Session | 3 AM - 9:30 AM | Volatility increases, pre-market |
| US Cash Open | 9:30 AM - 4 PM | Highest volume, best liquidity |
| After Hours | 4 PM - 6 PM | Earnings reactions, news |
⏰ Best Times to Trade
- 9:30-11:30 AM ET: Opening range — highest volume, best setups
- 2:00-4:00 PM ET: Closing action — institutional positioning
- Avoid 12:00-2:00 PM: "Lunch chop" — low volume, erratic moves
Expiration and Contract Rollover
Every futures contract has an expiration date. Most index futures expire quarterly (March, June, September, December), while commodity futures often have monthly expirations.
The Rollover Process
Traders who want to maintain exposure beyond expiration must "roll" their position:
📅 How to Roll a Position
- Close the expiring contract
- Simultaneously open a position in the next available contract month
- Account for any price difference between contracts
📈 Contango
When future contract prices are higher than the spot price. This is normal for most markets and reflects carrying costs (storage, insurance, financing).
📉 Backwardation
When future prices are lower than the spot price. This often occurs in commodity markets during supply shortages when immediate delivery commands a premium.
Who Uses Futures and Why
🏢 Hedgers
Commercial entities use futures to lock in prices and reduce uncertainty. A farmer might sell corn futures to guarantee a price for their harvest. An airline might buy oil futures to protect against rising fuel costs. Portfolio managers use index futures to hedge equity exposure.
💰 Speculators
Traders seeking to profit from price movements without any commercial interest in the underlying asset. Speculators provide crucial liquidity to the markets and assume the risk that hedgers want to transfer.
⚡ Arbitrageurs
Sophisticated traders who exploit price discrepancies between related markets. Their activity helps keep futures prices aligned with fair value and improves overall market efficiency.
Getting Started with Futures
🚀 Steps to Begin Trading Futures
- Education First: Understand the products, mechanics, and risks thoroughly
- Choose a Broker: Select a futures broker with competitive commissions and reliable platform
- Paper Trade: Practice with a simulator before risking real capital
- Start Small: Begin with micro contracts to limit risk while learning
- Risk Management: Never risk more than 1-2% of your account on any single trade
- Know Your Contracts: Understand tick size, value, and margin requirements
Key Takeaways
Futures contracts offer powerful tools for speculation and hedging, with benefits like extended trading hours, leverage, and favorable tax treatment. However, the same leverage that amplifies gains can quickly devastate an account if risk isn't managed properly.
Success in futures trading requires understanding contract specifications, managing margin carefully, and maintaining strict discipline. Start with education, practice extensively, and always respect the power of leverage.