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20
Feb

What Is a Futures Contract

Futures are contracts that give buyers the obligation to buy an asset or commodity, and the seller the obligation to sell that asset or commodity, at an agreed upon price at a future point in time. Because this agreement is binding and not simply an option to buy or sell the underlying asset, futures are justly called futures contracts. Futures contracts are traded on a broad variety of underlying assets, including commodities such as grain, gold, silver, electricity production, crude oil, beef, pork, orange juice, sugar, natural gas and more. Additionally, futures contracts are also based on underlying securities, such as forex currencies, interest rates, bonds and equities.

It is important to note that futures contracts are standardized. For the same underlying asset, the asset’s quantity (i.e., 10 tons of wheat), quality (i.e., wheat grades such as “U.S. No. 1”), delivery date (i.e., “June 1st, 2017”) and location (i.e., “New York City”) are standard.

Futures contracts are legally binding contracts. If a buyer has a forex futures contract to purchase 1,000,000 Japanese Yen at a forex rate of US$00.001 on September 1st, and that forex futures contract is not closed out by the delivery date – if it was sold to another buyer, or sold and replaced with another forex futures contract with a later delivery date – the buyer must then purchase the underlying commodity or asset at the agreed to price. 

Buyers rarely if ever actually take physical delivery of the underlying commodity, but instead purchase the rights, on paper, to take delivery of the asset or commodity. Conversely, if the seller of the forex futures contract is obligated to deliver those 1,000,000 Japanese Yen at a forex rate of US$00.001 by September 1st, and they do not close out their forex contract, they would be obligated to sell those 1,000,000 Japanese Yen to the other party in the forex futures contract.

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