What are futures?

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A futures contract is an agreement between a buyer and a seller. It obligates the buyer to take possession of a specified amount of a given commodity or financial instrument and to do so by a given date. Likewise, it obligates the seller to deliver (sell) a specified amount of a given commodity or financial instrument by a given date. The specified date is the expiration date of the futures contract. Futures contracts lock in current prices, that is, the prevailing prices at the time the contracts were bought or sold. This protects both the buyer and seller against the risk of price change between the moment of the contract transaction and the time of delivery (the expiration date). Futures contracts can be bought or sold at any time by anyone and they can change hands any number of times before expiration.

Related to the expiration date is the first notice date. This is the date after which the contract holder may be required to take possession (if long) or to deliver (if short) the specified quantity of the underlying commodity. After first notice date, those who are long futures contracts can demand delivery and those who are short may be required to deliver. Futures speculators who want to maintain a position past first notice date “-roll over”- their contracts to others that have later expiration dates.

Futures contracts may be used in several ways. For example, producers of commodities use them to hedge risks. A grain producer may have 10,000 bushels of corn that will be ready on a given date, and he or she wants to lock in specific sales price on that date. Locking in the price with a futures contract avoids the risk of vagaries in the corn market. Consequently, the use of futures allows the producer to budget and plan, knowing what price to expect on delivery. The way the producer ensures the price is by selling futures contracts. The buyer of futures contract is then obligated to take delivery of the corn on a given date, at the specified price.

For the speculator [or] day trader, futures contracts are used purely as trading instruments. They enable profits to be made from correctly anticipated price changes. For example, a trader expecting stocks to rise can profit from the anticipated move by going long an S&amp-P 500 or E-Mini contract. To avoid acquiring the commodity and then having to turn around and sell it, speculators generally do not hold futures contracts past expiration or first notice date.

Today, futures trading on modern exchanges is highly standardized. Future contracts have fixed expiration dates and contract sizes, and each contract is identified by a unique symbol. Specifying a futures contract, such as when requesting a quote or placing an order, requires knowledge of the month in which the contract terminates or expires, and the root symbol used to identify the contract series.

Tony Reed

Cross-posted from “-What are futures?“-. Please, visit Tony Reed’-s home page, Futures Trading &amp- Futures Market, for more information.

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