Loading the player...

What are 'Futures'

Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset, such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash.

BREAKING DOWN 'Futures'

The futures markets are characterized by the ability to use very high leverage relative to stock markets. Futures can be used to hedge or speculate on the price movement of the underlying asset. For example, a producer of corn could use futures to lock in a certain price and reduce risk, or anybody could speculate on the price movement of corn by going long or short using futures.

The primary difference between options and futures is that options give the holder the right to buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfill the terms of his contract. In real life, the actual delivery rate of the underlying goods specified in futures contracts is very low as the hedging or speculating benefits of the contracts can be had largely without actually holding the contract until expiry and delivering the good. For example, if you were long in a futures contract, you could go short in the same type of contract to offset your position. This serves to exit your position, much like selling a stock in the equity markets closes a trade.

Futures Speculation

Futures contracts are used to manage potential movements in the prices of the underlying assets. If market participants anticipate an increase in the price of an underlying asset in the future, they could potentially gain by purchasing the asset in a futures contract and selling it later at a higher price on the spot market or profiting from the favorable price difference through cash settlement. However, they could also lose if an asset's price is eventually lower than the purchase price specified in the futures contract. Conversely, if the price of an underlying asset is expected to fall, some may sell the asset in a futures contract and buy it back later at a lower price on the spot.

Futures Hedging

The purpose of hedging is not to gain from favorable price movements but prevent losses from potentially unfavorable price changes and in the process, maintain a predetermined financial result as permitted under the current market price. To hedge, someone is in the business of actually using or producing the underlying asset in a futures contract. When there is a gain from the futures contract, there is always a loss from the spot market, or vice versa. With such a gain and loss offsetting each other, the hedging effectively locks in the acceptable, current market price.

RELATED TERMS
  1. Futures Contract

    An agreement to buy or sell the underlying commodity or asset ...
  2. Options On Futures

    An option on futures gives the holder the right, but not the ...
  3. Contract Month

    The contract month is the month in which a futures contract expires.
  4. Forward Delivery

    Forward delivery is the final stage in a forward contract when ...
  5. Forward Contract

    A customized contract between two parties to buy or sell an asset ...
  6. Unlimited Risk

    Unlimited risk is when the risk of an investment is has unlimited. ...
Related Articles
  1. Investing

    A Quick Guide for Futures Quotes

    Here is a quick guide for reading and understanding futures markets quotes.
  2. Investing

    Getting Started In Foreign Exchange Futures

    Learn how these futures are used for hedging and speculating, and how they are different from traditional futures.
  3. Investing

    What is a Forward Contract?

    A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date.
  4. Investing

    Trading gold and silver futures contracts

    Gold and silver futures contracts offer a world of profit-making opportunities for those interested in hedging securities or a speculative plays.
  5. Trading

    A Quick Guide To Debt Options

    Options on debt instruments provide an effective way for investors to manage interest rate exposure and benefit from price volatility, learn more today.
  6. Trading

    Curious About Stock Index Futures? Read This First

    You've mastered investing in individual stocks...now what? If you like a challenge, consider stock index futures. Just be careful.
RELATED FAQS
  1. How do I set a strike price for a future?

    Find out why futures contracts don't have set strike prices like options or other derivatives, even though price change limits ... Read Answer >>
  2. Why do futures' prices converge upon spot prices during the delivery month?

    Learn why as the delivery month of a futures contract approaches, the future's spot price will generally inch toward or even ... Read Answer >>
  3. How do S&P 500 futures work?

    Learn about the mechanics of S&P 500 futures contracts, a type of stock index future introduced by the Chicago Mercantile ... Read Answer >>
Trading Center