Futures Contract Definition
A futures contract is a legal agreement to buy or sell a particular commodity or asset at a predetermined price at a specified time in the future. The buyer of the futures contract is taking on the obligation to buy and receive the underlying asset when the futures contract expires. The seller of the futures contract is obligated to provide the underlying asset at the expiration date.
Futures Contract Key Points
- A futures contract is a standardized legal agreement between two parties to buy or sell a specific asset at a predetermined price in the future.
- It is used to hedge against price fluctuations and for speculative purposes.
- Futures contracts are traded on exchanges and are settled on a daily basis.
- The parties involved in a futures contract are obligated to fulfill the contract on the settlement date.
What is a Futures Contract?
A futures contract is a derivative financial instrument. This means its value is derived from the value of an underlying asset. The underlying asset can be a commodity (like gold, oil, or wheat), a financial instrument (like a bond or a stock), or a cryptocurrency (like Bitcoin or Ethereum). The main purpose of a futures contract is to secure the price of the underlying asset for a future date, thus providing a hedge against price fluctuations.
Why are Futures Contracts important?
Futures contracts are important for two main reasons. Firstly, they allow businesses to mitigate the risk of price fluctuations in the assets they need for their operations. For example, an airline company might use futures contracts to lock in fuel prices for a future date, protecting itself against potential increases in fuel prices. Secondly, futures contracts are used for speculative purposes. Traders can profit from price changes in the underlying asset without actually owning the asset.
Who uses Futures Contracts?
Futures contracts are used by a wide range of participants, including businesses, investors, and speculators. Businesses use futures contracts to hedge against price changes in the commodities or assets they need for their operations. Investors use futures contracts to gain exposure to certain assets without having to own them directly. Speculators use futures contracts to bet on the future price movements of the underlying assets.
When are Futures Contracts used?
Futures contracts are used whenever there is a need to secure a future price for an asset or to speculate on the price movement of an asset. They are traded on futures exchanges, which provide a marketplace for buyers and sellers to interact. The contracts are standardized in terms of quantity, quality, and delivery time and location.
How do Futures Contracts work?
When a futures contract is bought or sold on an exchange, the buyer agrees to purchase a specific asset, and the seller agrees to sell that asset at a set price on a future date. The contract is settled on a daily basis, meaning that the difference between the daily market price and the contract price is settled daily. The party that is in a loss position must pay the difference to the party in a gain position. This process is known as marking to market. When the contract expires, the final settlement is made, and the asset is delivered to the buyer.
