A trade is just a transfer of risk at an agreed price. Everything else — the exchange, the contract, the margin, the screen — exists to make that transfer fast, fair and enforceable. Keep that sentence in mind and the machinery stops being intimidating.
1.1What a market is
A market is any venue where buyers and sellers agree prices. The price you see quoted is simply the most recent point at which someone willing to sell and someone willing to buy agreed. Two structures dominate.
Exchange-traded markets (the NYSE, CME, ICE, LME) are centralised. Orders meet in a single order book, prices are public, and a central counterparty (CCP) — the clearing house — steps between every buyer and seller. Once your trade clears, you no longer face the person on the other side; you face the clearing house. That is the single most important risk-reducing invention in modern markets: it means one defaulting trader doesn't topple their counterparties like dominoes.
Over-the-counter (OTC) markets are bilateral. You deal directly with a bank or dealer — most bonds, FX spot, and swaps trade this way. Prices are negotiated, liquidity lives on dealer balance sheets rather than in a public book, and you carry counterparty risk: if your dealer fails before settling, you are an unsecured creditor.
Settlement & the clearing house
When you trade, two things must happen: the asset moves one way and cash moves the other. This is settlement. Equities in most markets settle T+1 (one business day after trade). The clearing house guarantees it by collecting margin (a good-faith deposit) from both sides and marking positions to market daily — concepts we make concrete in 1.3.
"The market" is not one thing. For a single name like Apple you might trade the primary listing, dozens of dark pools, single-stock options, the stock as a component of ES via the S&P, and synthetically via a swap. Each venue has its own depth and its own quirks. A pro's instinct is to ask which venue offers the tightest spread and least market impact for the size they need — not to assume the headline screen price is available in their clip.
1.2The instrument family tree
Almost every position you will ever take is one of the following, or a package of them. Learn the family and any new product becomes "oh, that's just an X with a Y bolted on".
| Instrument | What it is | You'd use it to… |
|---|---|---|
| Spot / cash | Buy the actual asset now (a share, an ounce, a barrel). | Own the thing outright; no expiry, no leverage by default. |
| Forward | A private agreement to trade at a set price on a future date. | Lock a price; bespoke, OTC, settled at the end. |
| Future | A standardised, exchange-traded forward, marked daily. | Take leveraged, liquid directional exposure; hedge. |
| Option | The right, not the obligation, to buy (call) or sell (put) at a strike. | Define risk, express views on direction and volatility. |
| Swap | Exchange one cash-flow stream for another (e.g. fixed for floating). | Transform exposure — rates, total return, basis. |
| ETF / ETN | An exchange-listed wrapper holding assets (ETF) or an issuer note (ETN). | Get diversified or hard-to-reach exposure in a share you can buy in any brokerage. |
| CFD | Contract for difference — pay/receive the price change vs entry. | Leveraged retail exposure (banned in some jurisdictions, e.g. the US). |
Three distinctions matter more than the labels. Obligation vs right: futures and forwards commit you; options give you a choice you pay for. Funded vs leveraged: spot and ETFs are paid for in full; futures, options and CFDs let you control a large notional with a small deposit. Linear vs non-linear: a future's P&L moves one-for-one with the underlying; an option's does not, because of the Greeks (1.6).
1.3Futures in depth
Futures are the backbone of professional trading in indices, rates and commodities, so we go slowly. A future is a contract to buy or sell a fixed quantity of something, at a price agreed today, for delivery (or cash settlement) on a set date. It is standardised by the exchange so it can trade in a deep public book.
The contract specification
Every future has a spec sheet. Here is the E-mini S&P 500, the most-traded equity index future in the world, as a template you will see repeated throughout the manual.
ESNotional value — the size you actually control
The notional is the real economic exposure, not the margin you post. Get this wrong and you will be ten times bigger than you think.
With the S&P 500 at 5,400 and the ES multiplier of $50:
One ES contract gives you the exposure of $270,000 of the index. If exchange margin is, say, ~$13,000, you are controlling that $270,000 with about 5% down — roughly 20:1 leverage. The Micro E-mini (MES) is one-tenth the size — $5 × index, so $27,000 notional here — which is how smaller accounts size sensibly.
Tick size and tick value — what one wiggle is worth
You buy 2 ES at 5,400.00 and sell at 5,412.50.
Move = 5,412.50 − 5,400.00 = 12.50 points = 12.50 ÷ 0.25 = 50 ticks
P&L = 50 ticks × $12.50 × 2 contracts = $1,250
Shortcut: since the multiplier is $50, each full index point is worth $50 per contract, so 12.5 points × $50 × 2 = $1,250. Same answer, two routes.
Margin and daily mark-to-market
You don't pay the notional. You post initial margin to open and must keep equity above the maintenance margin. Each day the exchange revalues your position to the settlement price and moves cash in or out of your account — mark-to-market. Profits are credited daily and can be withdrawn; losses are debited daily, and if your equity falls below maintenance you get a margin call.
Long 1 ES. Initial margin $13,200, maintenance $12,000. Account starts at $13,200.
Equity = 13,200 − 1,000 = $12,200 (above 12,000 → OK)
Day 2 settles 5,365 → another −15 pts × $50 = −$750
Equity = 12,200 − 750 = $11,450 (below 12,000 → margin call)
To restore initial: deposit 13,200 − 11,450 = $1,750
This daily cash-flow is why futures can't quietly drift to ruin the way an unmonitored loan might — the loss is taken from you every single day, in cash. It is also why undercapitalised accounts get stopped out by the clearing system, not just by the market.
Beginners size off margin ("I have $50k, margin is $13k, so I can hold 3 contracts"). Professionals size off notional and volatility. Three ES is $810k of beta-1 equity exposure on a $50k account — a single bad session can be 15–20% of the account. Margin tells you what the exchange needs; it says nothing about what you can survive. Sizing is done in 1.7.
1.4The forward curve, contango & roll yield
Because a future has an expiry, there is a different price for each delivery month. Plot those prices against their expiry dates and you get the forward curve (or term structure). Its shape is one of the most information-rich and most misunderstood objects in markets.
- Contango: further-dated contracts cost more than near ones — an upward-sloping curve. Typical when storage is plentiful and carry costs dominate.
- Backwardation: further-dated contracts cost less than near ones — a downward curve. Typical when there is a shortage now and people pay up for immediate delivery.
Why the curve has shape: cost of carry
For a storable asset, the fair forward price is today's spot plus the cost of holding it to delivery — financing, storage, insurance — minus any benefit of holding it (a dividend for a stock, or the convenience yield for a commodity you might actually need on hand).
Spot gold S = $2,300/oz, one-year financing r = 5%, storage+insurance s = 0.5%, convenience yield y ≈ 0%:
The one-year future "should" trade near $2,426.50. The $126.50 premium is the carry — it is not a forecast that gold will rise. This is the trap in the next box.
Roll yield — the cost (or gift) of staying invested
A future expires, so to hold exposure over time you must roll: close the expiring contract and open the next one. In contango you sell low (the cheap front) and buy high (the pricier next month) every roll — a steady bleed. In backwardation you sell high and buy low — a tailwind.
Front-month crude $78.00, second month $78.80 (contango). You must roll from front to second:
Twelve monthly rolls at this slope ≈ −12% a year, before any price move.
So a commodity ETF can lose ~12% while spot is flat, purely from rolling up a contango curve. Flip the prices (front $78.80, next $78.00) and the same maths gives a +1.03% tailwind each roll in backwardation.
Retail buys USO "because oil will go up", oil does go up over the year, and they still lose money — because the front of the curve was in steep contango and the roll bled faster than spot rose. Whenever you take commodity exposure through a rolling product, your real question is not "where is spot going?" but "where is spot going relative to what the curve has already priced, net of roll?" We return to this in Parts 4–5; it is that important.
1.5ETFs, ETNs & why leveraged products decay
An ETF (exchange-traded fund) is a basket of assets sliced into shares that trade like a stock. An ETN (exchange-traded note) is not a fund — it is an unsecured debt promise from a bank to pay you an index's return. That difference matters: an ETN carries issuer credit risk. If the bank fails, your ETN can go to zero even if the index it tracks is fine (this is not hypothetical — Lehman's ETNs did exactly that).
Physical vs synthetic replication
Physical: the fund actually holds the underlying (SPY holds the 500 stocks; GLD holds gold bars). Synthetic: the fund holds a swap with a bank that promises the index return — cheaper to run and good for hard-to-hold markets, but adds counterparty exposure.
Creation/redemption keeps price near value
Large players (authorised participants) can swap a basket of the underlying for new ETF shares, or vice versa. If the ETF trades above the value of its holdings (its NAV), they create and sell; if below, they redeem and buy. This arbitrage is what keeps an ETF's price glued to what it owns. Tracking error is the small residual gap, driven by fees, the roll (1.4) and replication slippage.
Leveraged ETFs target a multiple of the daily return and reset every day. That daily reset means a flat-but-choppy market grinds them down. Index starts at 100; a 3× fund starts at $100.
Day 2: index −9.09% → back to 100. 3× = −27.27% → 130 × 0.7273 = $94.55
Index round-trip: 0%. 3× fund: −5.45%
The index ended exactly where it began; the leveraged ETF lost 5.45%. Repeat across a sideways month and the decay compounds. These are daily trading tools, not buy-and-hold positions — the prospectus says so, and the maths enforces it.
1.6Options — the right, not the obligation
An option is the right to buy (a call) or sell (a put) the underlying at a fixed strike price before/at expiry. The buyer pays a premium for that right; the seller (writer) collects the premium and takes on the obligation. The buyer's loss is capped at the premium; a naked seller's loss can be large. That asymmetry is the whole point.
Buy one AAPL $200 call for $5.00 (×100 shares = $500 cost). At expiry spot = $212:
Profit = (12 × 100) − 500 = 1,200 − 500 = $700
Break-even spot = strike + premium = 200 + 5 = $205
Below $200 the call expires worthless and you lose only the $500 premium — your maximum loss, known the moment you trade.
The Greeks — what your option is sensitive to
| Greek | Measures sensitivity to… | Plain English |
|---|---|---|
| Delta | price of the underlying | How much the option moves per $1 move in the underlying (also ≈ probability of finishing in-the-money). |
| Gamma | delta itself | How fast delta changes — your exposure accelerates near the strike. |
| Theta | time | Daily decay. Options are wasting assets; theta is the rent the buyer pays. |
| Vega | implied volatility | How much the premium moves when the market's expectation of future movement changes. |
Implied volatility (IV) is the market's forecast of future movement baked into the price; realised volatility is what actually happens. Much of professional options trading is a bet on the gap between the two — which is exactly what the VIX (Part 2) packages into an index.
Buy a call and you are long direction and long volatility and short time. New traders are "right on direction" yet lose because IV collapsed after an event (vega) or the move took too long (theta). Define the trade by all three. Simple structures help: a vertical spread (buy one strike, sell another) caps cost and dampens vega/theta; a collar (own stock, buy a put, sell a call) fences a position's range for little or no premium.
1.7Leverage, margin & position sizing
This is the section that keeps you in the game. Edge gets you returns; sizing decides whether you live long enough to realise them.
Account $100,000, risk 1% per trade. Long crude CL at $78.00, stop $76.50. CL = 1,000 bbl, so $1 move = $1,000/contract.
Risk per contract = (78.00 − 76.50) × 1,000 = 1.50 × 1,000 = $1,500
Contracts = 1,000 ÷ 1,500 = 0.67 → trade 0 or, with micros, size down
The maths says one full CL risks $1,500 — more than your 1R limit — so you either skip it, widen the account, or use a smaller contract. The stop distance, not your conviction, sets the size. Targeting a 2R or 3R reward means risking $1,000 to make $2,000–$3,000, so you can be wrong more than half the time and still compound. [Calc] mirrors the Position Size calculator on the site.
Account $100,000 holding 2 ES at 5,400 (notional $270,000 each):
A 2% index drop = 2% × $540,000 = −$10,800, or −10.8% of the account, from a move the news would call "quiet". Always compute this number before sizing up; margin will happily let you run far hotter than you should.
1.8Reading the tape
The last foundation is mechanical literacy at the point of execution.
- Bid / ask / spread: the bid is the highest price buyers will pay, the ask the lowest sellers will take; the gap is the spread — a real cost you pay on entry and exit. Tight spreads = liquid; wide = illiquid or fast.
- Volume vs open interest: in futures and options, volume is contracts traded today; open interest is contracts still open (not yet closed out). Rising price on rising open interest = new money committing; rising price on falling OI = shorts covering, a weaker signal.
- Depth (the book): how much size rests at each price. Thin books mean your own order moves the price (market impact).
Order types
| Order | Does | Trade-off |
|---|---|---|
| Market | Fills immediately at best available price. | Certain fill, uncertain price — dangerous in thin books. |
| Limit | Fills only at your price or better. | Certain price, uncertain fill — you may be skipped. |
| Stop | Becomes a market order once a trigger trades. | Protects you, but can fill far away on a gap. |
| Stop-limit | Becomes a limit order at the trigger. | Controls fill price, risks no fill in a fast move. |
| MOC / LOC | Market/limit on close — fills at the closing auction. | Matches the official close; no intraday control. |
Market orders in liquid ES at midday cost almost nothing; the same order in an illiquid soft like orange juice, or any market in the seconds around a data release, can slip multiple ticks. The discipline: use limits to add liquidity when you can wait, and reserve market orders for when getting out now is worth more than the spread. Over a year, execution quality is often a larger line item than people's actual directional edge.
That's the toolkit. You now know what a market is, every instrument you can deploy, how futures are sized and margined, why the curve's shape costs or pays you to stay invested, how ETFs track (and leveraged ones decay), what an option is really exposed to, how to size a trade off risk rather than ego, and how to read the point of execution. Every Part from here applies these same ideas to a specific market.