Wikipedia answers: A Futures Market, is an international financial exchange that allows people to trade Futures Contracts. So what exactly is the Futures Contract? Futures Contracts are legally binding agreements to buy certain quantities of financial instruments or commodities at a given price, with delivery at an agreed-upon future date – visit us!
Contract must be stressed. Futures Markets trade contracts and not stocks. This is the first difference that makes the Futures Market different from, say, Stock Markets. This isn’t a transaction where you buy and sell a piece (or share) of an organization. Futures Contracts is a contract between two investors for the trading of specific quantities of commodities or financial instruments, such as gallons gas or tons wheat.
How commodities function is easy to grasp. It is easy to understand how commodities work.
Southwest Airlines earned money while the other airlines lost it when fuel prices were $140/barrel. Years earlier, when oil was cheaper, Southwest Airlines had signed Futures Contracts. But they didn’t take delivery of the contracts until 2007. Futures Contracts will be purchased for 2011/2012 when the price of crude oil drops.
But that isn’t using a trading strategy or a trading systems, it’s just negotiating.
There is some risk in every Futures Contract. Futures Contracts allow you to reduce your risk by using the value of underlying assets.
Southwest purchased risk. The company paid more than it had to if they were unable to get the contract price for crude. Simultaneously reducing risk as they expected the price of crude to rise higher than their contracted price. Their leverage proved profitable.
Consider the oil companies. As they thought crude oil price would be below contract price, Southwest reduced the risk. Oil prices rose more than their contract price, resulting in a loss of revenue. This was because their leverage wasn’t as high as it could have possibly been.