What’s the difference between futures and daily rolling prices?

I found out this week that my eldest son is a futures trader.

It was a surprise to me, as he’s only eight years old. But I overheard him negotiating with his brother …

“If I let you borrow this toy until bedtime, you give me your advent calendar chocolate tomorrow.”

And who thought that futures trading was complicated?

The only confusing thing about the futures market is some of the language that traders use to describe it. The principles can be understood by any 8-year-old keen to take advantage of his younger sibling.

The futures market has a very long history.

In fact, the earliest recorded futures contract appears in Aristotle’s Politics, where he tells the story of Thales, a poor philosopher, who was challenged with the age-old question, “If you’re so smart, why aren’t you rich?” According the Aristotle’s story, Thales set out to prove that he could use his knowledge to make money. He made a forecast of the weather conditions (using his knowledge of stars and heavens) for the coming season and predicted that there would be a bumper crop of olives come harvest time. He then took whatever little money he had and went to all the owners of the olive presses. He made an agreement with each of them, for a deposit, to use their presses exclusively during the harvest time. He got good terms on his agreements, as the press owners were very happy to have an up-front payment. And when the harvest arrived with a bumper crop, Thales, having cornered the olive press market, really made a killing. He could charge whatever he wanted for the use of olive press by the other merchants.

Strictly speaking, this is more of an option than a futures contract, but it shows just how simple these concepts are to understand when we don’t use technical terms like ‘futures’, ‘options’ or ‘derivatives’.

Investing in a futures contract simply means that you agree to purchase a specified thing (be it a commodity, a financial instrument, use of an olive press, or one of your sibling’s chocolates) at a specified date in the future, but at a price that is set today.

By agreeing to a futures contract you hope that the commodity or financial instrument you are investing in will rise in price by the time your contract expires.

You can of course trade your contract before its expiry date to another trader on the futures market, hopefully making a profit in doing so.

The futures market began as a way for farmers to get a fair deal.

Let’s say that a farmer was producing wheat. Rather than just turn up at market come harvest time and try to find a buyer, he’d form a contract with the dealer for a certain quantity on a certain date, for a fixed price.

The futures market was born.

Over the years, the futures market grew from just a handful of farm products to include a vast number of tradable commodities, plus instruments like indices, stocks and currencies.

And in this way, investors began to use these futures markets to speculate on the price of these instruments and commodities going up or down in the future.

So, the price of a futures contract will be slightly different to the “spot” price – which is the “here and now” price.

If the market sentiment is that the price is going to go up – then the futures price will be higher. And conversely, if the sentiment is that the price will go down, the futures price will be lower than the spot price.

Some of the higher price in a futures contract is to do with factors other than predicted price rises … storage, for example, in the case of something like gold … or risk, such as weather and political events, in the case of things like cotton or oil …

But what about spread betting the futures market?

On most  spread betting platforms, you’ll find “rolling daily” or “spot” prices, alongside “futures” prices.

Just as when you spread bet, you don’t actually buy or sell anything – you’re just betting on a price change. So, when you spread bet on futures, you’re not actually purchasing a futures contract of any kind.

Instead, you’re just speculating on whether the price of a particular futures contract will go up or down.

This means that, in terms of how you make money – it’s no different from betting on a daily cash (or ‘spot’) price. You can bet that the price will go up … or that it’ll go down.

Where it is very different is in how you are charged by your spread-bet provider.

Rolling daily, or ‘spot’ trades tend to have the tightest spreads, but they attract overnight financing charges if they are kept open from one day to the next. If you’re day trading, this makes it the cheapest way to trade; but if you’re holding onto your trades for more than a week or so, this will seriously eat into your profits.

Spread bets on futures contracts, however, will expire on the day that the futures contract expires. The spread will tend to be wider on these, but there are no overnight charges. Over time, this will work out considerably cheaper if you’re holding trades longer term.

So, if you’re looking at taking longer term positions (which, all in all, tend to be the most profitable area of spread betting) – use futures trades rather than rolling dailies.

My top recommendation for this style of trading is the Val Harrison’s HAV method, which has brought in a staggering £13,648 this year (all trading on weekly charts, so you’re only checking your trades once a week).

Related posts:

What is rolling cash price? Why do I spread bet futures?