Futures: Introductions and origins

You might have heard of futures before and thought they were either too complicated to get started with or only for large institutions. They can definitely sound a bit intimidating. However, much like options, futures aren’t just for institutions or professional traders. 

Over the past 20 years, futures have become increasingly popular among individual investors for a couple key reasons. 

First, futures allow individuals to gain exposure to the market without investing as much capital up front. The futures market offers a wide range of investment opportunities with contracts sized for every type of trader.

Second, futures allow investors to go either long or short, which lets investors use these contracts strategically in their portfolio. Not only can they speculate on price movements, but they can also manage risk and hedge their portfolios by locking in prices and potentially profiting from favorable market fluctuations.

So, where do futures come from?

Rooted in agriculture 

Futures originated in commodity markets, specifically for agricultural products. They ensured that buyers and sellers could lock in prices for crops ahead of harvest, hedging income and costs.

For example, if a farmer was going to harvest their corn, they might have sold a futures contract, agreeing to sell a set quantity of corn to a buyer at a specified price once the harvest came in.

This contract allows the farmer to cover costs and plan financially for the next few months, even if the price of corn falls. Similarly, it protects the buyer by guaranteeing the ability to purchase corn at a predetermined price, even if the market price rises.

Though the concept of futures dates back to the 1600s, the Chicago Board of Trade first introduced standardized futures in the United States in the 19th century.

Futures markets started to expand rapidly in the 1970s under the oversight of the Commodity Futures Trading Commission (CFTC), which was established through an act of Congress in 1974. Futures markets now cover a wide range of assets, including but not limited to crypto, equities, foreign currencies, natural gas, crude oil, precious metals, and many other commodities.

In the early 1980s, the CFTC approved cash-settled futures, allowing investors to settle contracts in cash rather than the physical delivery of commodities. These contracts quickly gained popularity due to their flexibility and ease of use, especially for financial products like equity indices.

This development further expanded the futures markets, attracting more institutional investors interested in speculating or hedging price movements across a broad range of assets. 

Current market context

Starting in the 1990s, smaller sized futures contracts were introduced. Their sizing lowered the capital requirements as well as risk exposure of full-sized contracts, making them more accessible to retail investors.

With the ability for more investors to gain exposure to a range of assets, futures trading has continued to grow in popularity. Retail investors are increasingly turning to futures as an investment strategy to protect their investments, especially in volatile markets. 

Coinbase Derivatives, LLC

Coinbase Derivatives evolved out of this modern futures market. It offers a variety of futures contracts that allow investors to gain exposure to crypto among other assets at a wide range of notional values.

Like other US futures exchanges, Coinbase Derivatives is regulated by the CFTC. All futures listed on Coinbase Derivatives are subject to the CFTC's comprehensive regulatory framework. They’re available for trading via CFTC-regulated brokers that offer futures trading, also referred to as Futures Commission Merchants (FCMs) and Introducing Brokers (IBs).

So why have futures gained popularity among retail investors? 

Accessible sizing 

Because Coinbase Derivatives offers a range of contract sizes, investors can gain exposure to the underlying assets—whether Bitcoin, Ether, or Dogecoin—at a fraction of the cost of investing in the asset itself. 

Risk management

While investors can speculate on futures to potentially profit when prices change in their favor, they can also use futures in their portfolio to mitigate risk. If an investor thinks one of their assets will go down in value, they can hedge it by going short futures on that asset, where they would profit from a decline in the price of the asset.

Tax advantages

Another benefit in futures trading is how realized gains and losses are taxed. Under Section 1256 of the U.S. Internal Revenue Code applicable to futures, the IRS splits investor gains and losses into two parts regardless of the holding period:

• 60% of gain or loss is taxed at the long-term capital gains rate, which is typically around 0-20%, depending on an investor’s income.

• 40% of gain or loss is taxed at the short-term capital gains rate, which is typically the same as the investor’s regular income tax rate.

This 60/40 split can work in the investor’s favor. Even if an investor holds a contract for less than a year, which would normally be a short-term investment, 60% of the gain would still get the lower long-term rate.

Key terms

Exchange

A marketplace where traders can buy and sell futures contracts. The exchange facilitates trading and ensures transparency, liquidity, and standardization.

Exposure

The degree to which an investor is affected by changes in the value of a contract’s underlying asset. Essentially, exposure represents the amount of risk—or potential profit or loss—that a trader could face due to market fluctuations.

Asset 

The commodity or financial benchmark a futures contract is based on. An asset or underlying asset can be: physical goods like oil or wheat; a financial instrument like foreign currencies; or an index like the S&P 500 or NASDAQ.

Going long

A position an investor takes if they anticipate the price of an asset to rise, much like buying a stock or an ETF.

Going short

A position an investor takes if they anticipate the price of an asset to fall. They would sell a contract in hopes of repurchasing at a lower price later.

While futures have gotten more popular in recent years, they didn’t just spring up overnight. Futures have a long history of use in commodities markets and have evolved to become more accessible for retail investors.