Futures contract

Futures_Trading_Composition

A futures contract is a standardized legal agreement to buy or sell a specific commodity or financial instrument at a predetermined price at a specified time in the future. Futures contracts are traded on a futures exchange, which acts as an intermediary and facilitates the trading process.

Structure and Function

Futures contracts are used for both hedging and speculation. The contract specifies the quantity of the underlying asset and is standardized to facilitate trading on the futures exchange. The buyer of a futures contract agrees to purchase the underlying asset at the contract's expiration date, while the seller agrees to deliver the asset.

Hedging

Hedging involves taking a position in a futures contract to offset potential losses in the spot market. For example, a farmer might sell futures contracts on their crop to lock in a price and reduce the risk of price fluctuations.

Speculation

Speculators aim to profit from price movements in the futures market. They do not intend to take delivery of the underlying asset but instead close out their positions before the contract's expiration date.

Types of Futures Contracts

Futures contracts can be based on a variety of underlying assets, including:

• Commodities (e.g., crude oil, gold, wheat)
• Currencies (e.g., Euro, Japanese yen)
• Stock indices (e.g., S&P 500, NASDAQ-100)
• Interest rates (e.g., U.S. Treasury bonds)

Margin and Leverage

Trading futures contracts involves the use of margin, which is a deposit made to cover potential losses. This allows traders to leverage their positions, meaning they can control a large contract value with a relatively small amount of capital.

Settlement

Futures contracts can be settled in two ways:

• Physical delivery: The actual commodity or asset is delivered at the contract's expiration.
• Cash settlement: The difference between the contract price and the market price is settled in cash.

Risks

Trading futures contracts involves significant risk, including the potential for substantial losses. It is important for traders to understand the risks and have a risk management strategy in place.

Related Pages

• Options contract
• Forward contract
• Derivative (finance)
• Commodity market
• Hedging
• Speculation
• Margin (finance)
• Futures exchange

See Also

• Financial market
• Risk management
• Leverage (finance)