A future contract, often simply referred to as a “future,” is an agreement between two parties to buy or sell a specified asset at a predetermined price and date in the future. Future contracts are typically traded on futures exchanges and are often used as a tool for hedging, speculation, and risk management.

One of the most significant features of future contracts is their standardized nature. Futures exchanges set the terms of the contract, including the underlying asset, contract size, expiration date, and tick size. This standardization allows for a high degree of liquidity and price transparency, which are essential for efficient trading.

To better understand how future contracts work, let’s consider an example. Suppose that a farmer wants to sell his crop of wheat, which will be ready for harvest in three months, at a fixed price. On the other hand, a bread manufacturer wants to buy wheat at a fixed price for the next three months to ensure stable production costs. The farmer and bread manufacturer could enter into a future contract in which the farmer agrees to sell a specific quantity of wheat to the bread manufacturer at a predetermined price three months from now.

If the price of wheat increases during the three-month period, the bread manufacturer will be happy as they purchased wheat at a lower price than what the current market is offering. If the price of wheat falls, the farmer will be happy as they will get more money than the current market price. Thus, the future contract ensures that both parties protect themselves from the price volatility of the wheat market.

Traders who participate in future markets can either be hedgers, who aim to reduce their exposure to fluctuations in the market, or speculators, who try to profit from price changes. Futures contracts can be used to trade a variety of assets, including commodities, currencies, and stocks.

Conclusion

In conclusion, future contracts are agreements between two parties to buy or sell a specific asset at a predetermined price and date in the future. They are commonly used for hedging, speculation, and risk management purposes. Standardization of future contracts ensures a high degree of liquidity and price transparency in the market. Understanding the concept of future contracts can be beneficial for market players who wish to participate in the futures market.