Futures contracts: Investment tool or risk trap?

Futures contracts are no longer a foreign concept in the global financial markets, but for Vietnamese investors, this remains a relatively new field. Since 2018, when the Vietnam Securities Exchange first allowed the listing of VN30 index futures contracts, the number of investors participating in this tool has remained limited. The main reason is a lack of understanding of how the mechanism works and how to apply futures contracts into practical investment strategies.

Roots and Applications of Futures Contracts

Futures contracts originate from the practical needs of traders — requiring a mechanism to protect themselves from price fluctuations of commodities. For example, airlines need to purchase fuel daily, while oil prices fluctuate unpredictably. To minimize the risk of sudden price increases, they sign futures contracts with suppliers, locking in the purchase price today for delivery tomorrow.

Today, futures contracts are no longer limited to commodities like crude oil or rice. All types of assets — from stocks, cryptocurrencies to gold — have futures traded on derivatives markets. This reflects the increasing demand for risk management from investors with large trading volumes.

How It Works: Buy Long or Sell Short?

When trading futures contracts, investors have two basic options:

Buy (Long): You sign a contract to buy the asset at maturity, predicting the price will rise.

Sell Short (Short): You sign a contract to sell the asset at maturity, predicting the price will fall.

Example illustration: Suppose you believe Brent oil (UKOIL) will increase in price by the end of October. You open a Long position to buy 1000 barrels at an agreed price of $43/barrel. If on October 20, the actual UKOIL price rises to $44, you can close the position immediately and realize a profit of $1,000. Conversely, if you open a Short position (selling short) at a price $43 and the price then drops to $42, you will need to buy back the contract at a lower level and earn a profit of $1,000.

Key Features of Futures Contracts

Standardization: Each futures contract is designed with clear parameters — asset type, volume, trading price, and maturity date are predefined.

Listing and Guarantee: Derivatives stock exchanges oversee the entire process, ensuring legal validity and safety for both parties.

Margin and Daily Settlement: To ensure both parties fulfill the contract, investors must deposit margin money. Profits and losses are settled daily based on market prices. If losses are too large, investors will be required to top up the margin to maintain their position.

Leverage: This is an extremely attractive but also the most dangerous feature. You only need to pay a small part of the contract value (margin) to trade the entire position. With a 1:10 leverage, if the price moves just 5% unfavorably, you could lose 50% of your initial margin.

Potential Risks in Trading

Leverage risk: While leverage can increase profits 4-5 times when predictions are correct, it also amplifies losses similarly when predictions are wrong.

Daily settlement: If the asset price fluctuates sharply against your expectations within a single day, you will incur an immediate loss. If you lack sufficient margin, your position will be forcibly liquidated.

Speculative nature: Trading futures contracts does not generate real value (such as increasing production or supply and demand). The “easy entry and exit” nature makes it a highly speculative tool with extremely rapid price movements, easily leading to total loss of capital.

CFD vs Futures Contracts: Which to Choose?

CFD (Contract for Difference) is also a derivative instrument but with fundamental differences:

Trading Venue: CFDs are traded over-the-counter (unregulated) through brokerage firms. Futures contracts are listed on official exchanges with strict oversight.

Expiration Date: CFDs have no fixed expiration date; you can hold the position as long as you want. Futures contracts have a defined expiration date, requiring you to predict price movements within a specific timeframe.

Capital Scale: CFDs are flexible from small to large scales. Futures contracts usually require larger initial capital due to standardized contract sizes designed for large-scale commercial markets.

Fees: CFDs incur overnight holding fees and spreads between bid and ask prices. Futures involve brokerage and exchange management fees.

Advantages of CFDs: Lower capital requirements, suitable for experienced investors aiming for short-term speculation across various assets. No obligation to settle by a specific date.

Advantages of Futures: Provide real risk hedging for investors engaged in commercial trading of assets. Backed by official agencies, offering greater safety.

Disadvantages of CFDs: High speculative element, with just 2-3% adverse movement potentially wiping out half of the capital. Requires continuous market monitoring.

Disadvantages of Futures: Large contract sizes, requiring high capital. Need to predict correct prices within limited timeframes. Additional fees for intermediaries.

Conclusion

Futures contracts are a double-edged sword. For large investors intending to buy and sell assets on a massive scale, they are a way to lock in prices and reduce risks. But for small investors or those only interested in speculation, the risks from leverage and daily settlement can wipe out entire capital within days.

CFD offers a more flexible alternative for those starting with smaller capital. Regardless of the tool chosen, the most important factors are understanding the mechanism, managing risks, and never investing beyond your capacity to bear losses.