what is a futures contract 
a futures contract is a legal agreement to buy or sell a particular commodity asset or security at a predetermined price at a specified time in the future futures contracts are standardized for quality and quantity to facilitate trading on a futures exchange the buyer of a futures contract is taking on the obligation to buy and receive the underlying asset when the futures contract expires the seller of the futures contract is taking on the obligation to provide and deliver the underlying asset at the expiration date investopedia joules garciaunderstanding futures contractsfutures are derivative financial contracts that obligate the parties to transact an asset at a predetermined future date and price 2 here the buyer must purchase or the seller must sell the underlying asset at the set price regardless of the current market price at the expiration date underlying assets include physical commodities or other financial instruments futures contracts detail the quantity of the underlying asset and are standardized to facilitate trading on a futures exchange futures can be used for hedging or trade speculation futures contract and futures refer to the same thing for example you might hear somebody say they bought oil futures which means the same thing as an oil futures contract when someone says futures contract they re typically referring to a specific type of future such as oil gold bonds or s p 500 index futures futures contracts are also one of the most direct ways to invest in oil the term futures is more general and is often used to refer to the whole market such as they re a futures trader futures contracts are standardized unlike forward contracts forwards are similar types of agreements that lock in a future price in the present but forwards are traded over the counter otc and have customizable terms that are arrived at between the counterparties futures contracts on the other hand will each have the same terms regardless of who is the counterparty application of a futures contractsfutures contracts are used by two categories of market participants hedgers and speculators producers or purchasers of an underlying asset hedge or guarantee the price at which the commodity is sold or purchased they use futures contracts to ensure that they have a buyer and a satisfactory price hedging against any changes in the market 3an oil producer needs to sell its oil they may use futures contracts to lock in a price they will sell at and then deliver the oil to the buyer when the futures contract expires similarly a manufacturing company may need oil for making widgets since they like to plan ahead and always have oil coming in each month they too may use futures contracts this way they know in advance the price they will pay for oil the futures contract price and they know they will be taking delivery of the oil once the contract expires since many commodity prices tend to move in predictable patterns it is possible to make a profit by trading futures even if one does not have a direct interest in the underlying commodity traders and fund managers use futures to bet on the price of the underlying asset 4for example a trader may buy grain futures if they expect the price of grain to increase before the delivery date any unexpected changes to the weather or growing conditions may cause the futures price to rise or drop types of futures contractsfutures contracts can be used to set prices on any type of commodity or asset so long as there is a sufficiently large market for it some of the most frequently traded types of futures are outlined below futures contract vs forward contracta futures contract is similar to a forwards contract where a buyer and seller agree to set a price and quantity of a product for delivery at a later date both types of contract can be used for speculation as well as hedging however there are also important differences while a futures contract is a standardized agreement that can be traded on an exchange a forward contract is simply a private agreement between a buyer and a seller while it is possible to trade forwards on otc markets they are less regulated and less accessible to retail investors this means that there are also more opportunities to customize a forward agreement according to the buyer s and seller s needs mechanics of a futures contractimagine an oil producer plans to produce one million barrels of oil over the next year it will be ready for delivery in 12 months assume the current price is 75 per barrel the producer could produce the oil and then sell it at the current market prices one year from today given the volatility of oil prices the market price at that time could be very different than the current price if the oil producer thinks oil will be higher in one year they may opt not to lock in a price now but if they think 75 is a good price they could lock in a guaranteed sale price by entering into a futures contract a mathematical model is used to price futures which takes into account the current spot price the risk free rate of return time to maturity storage costs dividends dividend yields and convenience yields assume that the one year oil futures contracts are priced at 78 per barrel by entering into this contract in one year the producer is obligated to deliver one million barrels of oil and is guaranteed to receive 78 million the 78 price per barrel is received regardless of where spot market prices are at the time contracts are standardized for example one oil contract on the chicago mercantile exchange cme is for 1 000 barrels of oil 6 therefore if someone wanted to lock in a price selling or buying on 100 000 barrels of oil they would need to buy sell 100 contracts to lock in a price on one million barrels of oil they would need to buy sell 1 000 contracts the futures markets are regulated by the commodity futures trading commission cftc the cftc is a federal agency created by congress in 1974 to ensure the integrity of futures market pricing including preventing abusive trading practices fraud and regulating brokerage firms engaged in futures trading 1trading futures contractsretail traders and portfolio managers are not interested in delivering or receiving the underlying asset a retail trader has little need to receive 1 000 barrels of oil but they may be interested in capturing a profit on the price moves of oil futures contracts can be traded purely for profit as long as the trade is closed before expiration many futures contracts expire on the third friday of the month but contracts do vary so check the contract specifications of any and all contracts before trading them for example it is january and april contracts are trading at 55 if a trader believes that the price of oil will rise before the contract expires in april they could buy the contract at 55 this gives them control of 1 000 barrels of oil they are not required to pay 55 000 55 x 1 000 barrels for this privilege though rather the broker only requires an initial margin payment typically of a few thousand dollars for each contract the profit or loss of the position fluctuates in the account as the price of the futures contract moves if the loss gets too big the broker will ask the trader to deposit more money to cover the loss this is called maintenance margin the final profit or loss of the trade is realized when the trade is closed in this case if the buyer sells the contract at 60 they make 5 000 60 55 x 1 000 alternatively if the price drops to 50 and they close out the position there they lose 5 000 