Futures Definition
A future is a financial contract obligating the buyer to purchase an asset, or the seller to sell an asset, at a predetermined future date and price. Futures contracts are standardized by exchange, and are traded on an exchange floor or electronically.
The most common types of assets traded in futures markets include commodities, securities, and currencies. However, almost any type of asset can be traded in a futures market if there is sufficient interest from buyers and sellers.
Futures markets exist because they provide traders with opportunities to hedge against price risk. For example, a farmer who is worried about the possibility of a decrease in the price of corn may choose to enter into a corn futures contract. If the price of corn falls below the contracted price, the farmer will make money on the difference. Similarly, if the price of corn rises above the contracted price, the farmer will incur a loss.
In addition to providing hedging opportunities, futures markets also allow traders to speculate on the direction of prices. Speculators typically seek to profit from changes in prices by taking positions in contracts that will gain in value if prices move in the desired direction.
The vast majority of futures contracts are closed out before delivery date. For example, most corn futures contracts are settled through cash settlement, meaning that no actual corn changes hands; rather, gains or losses are based on the difference between the contract price and the settlement price.
