Futures Contracts in trading are standardized legal agreements between two parties to buy or sell a specific asset at a predetermined price, to be executed and delivered on a specified future date.

Futures contracts are considered a type of financial derivative, as their value is derived from the value of the underlying asset, which can be:

Goods: such as gold, crude oil, wheat, and corn.

Indices: such as the S&P 500 or Nasdaq.

Foreign currencies: such as the euro against the dollar.

Other financial instruments: such as bonds.

Key characteristics of futures contracts

Futures contracts have several key characteristics:

Legal Commitment: Both the buyer (for purchasing) and the seller (for selling) are obligated to execute the transaction on the expiration date at the price agreed upon in the contract, regardless of the actual market price on that date.

Standardization: The terms of the contract, such as the quantity and quality of the underlying asset and the delivery date, are standardized by the exchange. This standardization facilitates their trading.

Trading on Exchanges: Futures contracts are traded on organized exchanges (Futures Exchanges), providing liquidity and transparency and reducing counterparty risk thanks to the presence of a clearinghouse that ensures execution.

Margin and Leverage: The trader does not need to pay the full value of the contract; they only need to deposit a small amount called the margin. This gives the trader leverage that allows them to control a large value of assets with a small capital, keeping in mind that it also increases the potential risk of loss. Uses of futures contracts

Futures contracts are used for two main purposes:

Hedging:

They are used by producers and consumers to protect themselves from price fluctuations. For example, a wheat farmer can sell futures contracts to lock in the price of their crop today, avoiding the risk of falling prices in the future. Conversely, a manufacturing company that uses wheat can buy futures contracts to lock in their purchase price, avoiding the risk of rising prices.

Speculation:

They are used by traders who expect the price movement of the underlying asset in the future. If a trader expects the price to rise, they buy a futures contract (long position), intending to sell it later at a higher price or settle the contract to make a profit. If they expect the price to fall, they sell a futures contract (short position), intending to buy it later at a lower price.

Illustrative Example

Let's assume the current price of crude oil is $80, and a trader expects its price to rise.

Entering the contract: The trader buys a futures contract for oil that expires in three months at a price of $82 per barrel.

Execution (after 3 months):

If the price rises to $90: the trader buys oil at the agreed price ($82) and can immediately sell it at the market price ($90), making a profit of $8 per barrel.

If the price drops to $70: the trader is still obligated to buy oil at the agreed price ($82), while the market price is $70, resulting in a loss of $12 per barrel.