Why Investors Use Futures

Trading futures contracts has both advantages and disadvantages.

Some advantages:

Futures are highly leveraged investments. To own a futures contract, an investor only has to put up a small fraction of the value of the contract (usually around 10%) as margin.  In other words, the investor can trade a much larger amount of the commodity than if she bought it outright, so if she has predicted the market movement correctly, her profits will be multiplied (ten-fold on a 10% deposit). This is an excellent return compared to buying a physical commodity such as copper or wheat.

Speculating with futures contracts is basically a paper investment. The actual commodity being traded in the contract is only exchanged on the rare occasion that delivery of the contract takes place. Since the average individual investor is a speculator, a futures trade is purely a paper transaction and the term "contract" is only used the futures contract has an expiration date.

Liquidity. Since there are huge amounts of futures contracts traded every day, futures markets are very liquid. This ensures that market orders can be placed very quickly as there are always buyers and sellers of a commodity. For this reason, it is unusual for prices to suddenly jump or fall dramatically, especially on the nearer contracts (those which will expire in the next few weeks or months).

Commission charges are small compared to other investments and are paid after the position has ended.  Commissions vary widely depending on the level of service given by the broker.

But they are lower than commissions on equities transactions. Online trading commissions can be as low as a few euros per trade.

Some disadvantages:

Leverage can work against you. Just as leverage can maximize your returns, it can also magnify your losses.

For example, let's say you wish to control 100 ounces of gold, and gold on that day is worth €9 000 per ounce. At that price, 100 ounces of gold would cost a total of €90,000, but you could control the entire 100 ounces of gold by putting down a €9,000 margin payment. If the price of gold rises, you will be credited the difference, but if the price drops, you will be responsible for coming up with additional margin capital in order to maintain control of the 100 ounces of gold. In essence, you are responsible for the entire €90,000 worth of gold.

Futures are a short-term investment. Unlike buying stocks, an investment in the futures market is not a long-term investment. Contracts run for a period of months, and the longer you hold the contract, the more margin calls you will be required to pay on its price. Therefore, you do not want to hold a commodity or instrument very long.

Futures trading requires constant monitoring. The trading of commodities is brisk, so you need to stay on top of the price constantly. A slight gain or loss can mean a lot of money.

For example, think back to the scenario above. If the price of gold goes up by €150 an ounce, you would make €5,000. However, a €150 an ounce drop would mean you would lose your €9,000 investment: this is the amount of your initial margin, which is a guarantee deposit. Moreover, you will be responsible for another €6,000 and lose this amount (your total loss is €15,000). In investing in futures, you can loose more than your initial investment.