Futures Contract
IntermediateA futures contract is a standardised agreement, traded on an exchange, to buy or sell a specific quantity of an asset at a set price on a future date.
Futures are similar to forward contracts, but with important differences. They have standard terms set by the exchange, covering quantity, quality and delivery dates, which makes them easy to trade. And they are guaranteed by a clearing house, which stands between buyers and sellers, greatly reducing the risk that one party will not pay.
Futures exist for commodities such as oil, wheat and gold, as well as for financial assets such as stock indices, government bonds, interest rates and currencies.
Traders must deposit margin, a fraction of the contract's value, with the clearing house. Gains and losses are settled daily, a process called marking to market. If prices move against a trader, they may need to add more margin.
For example, a trader buys an oil futures contract for 1,000 barrels at 80 per barrel. If the price rises to 85, the contract gains 5,000 in value; if it falls to 75, it loses 5,000.
Most futures contracts are closed before expiry rather than leading to actual delivery. They are used both for hedging and for speculation, and their leverage means gains and losses can be large relative to the margin deposited.
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