Future contract
A futures contract is a legally binding agreement to buy or sell a specific commodity, asset, or security at a predetermined price on a specified future date. These contracts are standardized in terms of quality and quantity to facilitate trading on futures exchanges.
When an individual buys a futures contract, they are assuming the responsibility to purchase and receive the underlying asset upon contract expiration. Conversely, the seller of the futures contract is obligated to provide and deliver the underlying asset at the designated maturity date.
Futures contracts are financial derivatives that require the involved parties to transact an asset at a predetermined price and future date. Regardless of the current market price at expiration, the buyer must buy or the seller must sell the underlying asset at the agreed-upon price.
Underlying assets can include physical commodities or other financial instruments. Futures contracts specify the quantity of the underlying asset and are standardized to facilitate trading on futures exchanges. These contracts are used for hedging against risks or for speculative trading purposes.
The terms “futures contract” and “futures” are often used interchangeably. For example, someone may mention buying oil futures, which means the same as an oil futures contract. The term “futures contract” typically refers to specific types of futures, such as oil, gold, bonds, or S&P 500 index futures. Futures contracts also provide a direct investment avenue for commodities like oil. On the other hand, “futures” is a more general term used to encompass the entire market, such as when someone refers to themselves as a futures trader.
Unlike forward contracts, futures contracts are standardized. Forward contracts are similar agreements that establish a future price in the present, but they are traded over-the-counter (OTC) and have customizable terms determined by the counterparties. In contrast, futures contracts maintain uniform terms regardless of the counterparty involved.
There are two main categories of market participants who use futures contracts: hedgers and speculators.
Hedgers are producers or purchasers of the underlying asset who utilize futures contracts to secure the price at which the commodity is bought or sold. They use these contracts to ensure a buyer or seller and protect against market fluctuations.
For instance, an oil producer may employ futures contracts to establish a predetermined selling price and subsequently deliver the oil to the buyer upon contract expiration. Similarly, a manufacturing company that requires oil as a raw material may use futures contracts to guarantee a steady supply at a known price. This way, they can plan ahead, knowing the future contract price and that they will receive the oil upon contract maturity.
Speculators, on the other hand, trade futures contracts to profit from price movements in the underlying asset, even without a direct interest in the commodity. Traders and fund managers engage in futures trading to speculate on the future price of the asset.
For example, a trader might purchase natural gas futures if they anticipate an increase in natural gas before the delivery date. Unforeseen changes in delivery or production conditions can cause fluctuations in futures prices.
Futures contracts can be applied to various types of commodities or assets, as long as there is a sufficiently large market for them. Some commonly traded futures categories include :
- Agricultural Futures : These contracts were among the first available in markets like the Chicago Mercantile Exchange. They cover grains, coffee, sugar, and even livestock, etc.
- Energy Futures : These contracts offer exposure to popular energy products like crude oil and natural gas.
- Metal Futures : Industrial metals, including gold, steel, and copper, are traded through these contracts.
- Currency Futures : These contracts enable participants to speculate on changes in exchange rates and interest rates among different national currencies.
- Financial Futures : Contracts tied to the future value of securities or indices, such as futures for the S&P 500 and Nasdaq indexes.
