Futures contract

In finance, a futures contract (sometimes called futures) is a standardized legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other. The asset transacted is usually a commodity or financial instrument. The predetermined price the parties agree to buy and sell the asset for is known as the forward price. The specified time in the future—which is when delivery and payment occur—is known as the delivery date. Because it is a function of an underlying asset, a futures contract is a derivative product.

Contracts are negotiated at futures exchanges, which act as a marketplace between buyers and sellers. The buyer of a contract is said to be the long position holder and the selling party is said to be the short position holder.[1] As both parties risk their counter-party walking away if the price goes against them, the contract may involve both parties lodging a margin of the value of the contract with a mutually trusted third party. For example, in gold futures trading, the margin varies between 2% and 20% depending on the volatility of the spot market.[2]

A stock future is a cash-settled futures contract on the value of a particular stock market index. Stock futures are one of the high risk trading instruments in the market. Stock market index futures are also used as indicators to determine market sentiment.[3]

The first futures contracts were negotiated for agricultural commodities, and later futures contracts were negotiated for natural resources such as oil. Financial futures were introduced in 1972, and in recent decades, currency futures, interest rate futures and stock market index futures have played an increasingly large role in the overall futures markets. Even organ futures have been proposed to increase the supply of transplant organs.

The original use of futures contracts was to mitigate the risk of price or exchange rate movements by allowing parties to fix prices or rates in advance for future transactions. This could be advantageous when (for example) a party expects to receive payment in foreign currency in the future and wishes to guard against an unfavorable movement of the currency in the interval before payment is received.

However, futures contracts also offer opportunities for speculation in that a trader who predicts that the price of an asset will move in a particular direction can contract to buy or sell it in the future at a price which (if the prediction is correct) will yield a profit. In particular, if the speculator is able to profit, then the underlying commodity that the speculator traded would have been saved during a time of surplus and sold during a time of need, offering the consumers of the commodity a more favorable distribution of commodity over time.[2]