Exploring the Main Types of a Futures Trade

The diverse opportunity for profit is one of the biggest benefits in the futures markets. Futures trading provides a wide range of advantages and possibilities to traders, ranging from actively controlling the level of risk in an investment portfolio to making predictions about future volatility in asset price. Let’s look at three main categories of a futures trade.

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What Are the Common Types of a Futures Trade

Basis Trading

A basis trade is categorized as an arbitrage strategy, which means that the trade’s objective is to benefit from the disparities in several futures contracts.

In order to execute a basis trade, opposing positions are taken in the markets of two or more comparable contracts. Profit is made when the initial pricing disparity is closed as the markets approach equilibrium. High levels of leverage are necessary since basis trading gains are typically the result of little price movements.

Because derivative products can be easily traded both against and alongside their underlying assets, basis trading is a popular activity in the futures commodities markets.

Hedging

Establishing an opposite position in a market or product that is inversely connected to counter the risks associated with a decline in asset pricing is known as hedging. Hedging can be used to lock in a guaranteed profit or protect the value of a hard asset, but its main purpose is to reduce risk.

Hedging can take many different forms, most of which depend on the asset class and general purpose of the trade in question:

Portfolio Diversification: Hedging with futures can help increase the portfolio’s diversity. For example, in order to lock in a profit and protect against a broad market decline, a short position in an equities futures product may be taken if the majority of the portfolio is made up of long stocks.

Speculation: In order to safeguard a short-term speculative position, futures traders frequently use hedging techniques. One popular method for controlling larger systemic risk while maintaining the integrity of an ongoing strategy or open position is to take positions in markets that are inversely connected.

Risk Management: The oldest type of risk management is producer hedging. For example, a commodities manufacturer may take a short position in a relevant futures market if they wish to protect themselves against unfavorable prices when their product is about to be delivered. Gains from the producer’s short position in the futures market will balance the producer’s losses in the event that the commodity’s price drops.

Spread Trading

Spread trading is an alluring option for traders who wish to lower the risk involved in holding a position that is only long or short in a particular futures market.

The act of having both a long and a short position in the same or associated markets is known as spread trading in futures. It aims to profit from price volatilities that are inconsistent when dealing with comparable contracts that have common or distinct expirations. Spread trading may be categorized into six classes:

Intra-commodity: Contrasting positions opened on the same product.
Inter-commodity: Contrasting positions opened on different products.
Intra-exchange: Positions are opened on the same exchange.
Inter-exchange: Positions are opened on different exchanges.
Intra-delivery: The contracts involved have a mutual expiration date.
Inter-delivery: The contracts involved have various expiration dates.

Adopting a spread-trading system has several benefits, including tight risk controls, uniform order entry, and lower margin needs.

The Bottom Line

When it comes to trading activities in futures, there are a plethora of options, each with its own technique and objective. Market participants seeking to increase their market share often employ strategies such as spread trading, basis trading, and hedging.