An Agreement to Buy or Sell at a Specific Date in the Future at a Predetermined Price
When it comes to financial transactions, there are many terms that can be confusing to the uninitiated. One such term is a “futures contract,” which is an agreement between two parties to buy or sell a specific asset on a predetermined date in the future, at a price that is agreed upon at the time the contract is created.
Futures contracts were originally used primarily in the agriculture industry, where farmers and buyers would agree to a price for a crop months in advance, in order to protect themselves from fluctuations in the market. Today, futures contracts are used in many different markets, including commodities, currencies, and stock indices.
The basic structure of a futures contract is simple: one party agrees to buy a certain quantity of an asset (such as barrels of oil or bushels of wheat) at a certain date in the future, and the other party agrees to sell that same quantity of the asset at the same date in the future. The price at which the transaction will take place is agreed upon when the contract is created.
For example, imagine that a wheat farmer wants to lock in a price for their crop before it has even been planted. They might enter into a futures contract with a buyer, agreeing to sell 1,000 bushels of wheat at a price of $5 per bushel, with delivery set for six months in the future.
If the market price of wheat rises above $5 per bushel over the next six months, the farmer will have made a smart move by locking in a price ahead of time. But if the market price falls below $5 per bushel, the buyer will have gotten a good deal by purchasing the wheat at a lower price than it would have been otherwise.
Of course, not all futures contracts result in an actual physical exchange of goods. Many are settled in cash, with one party paying the other the difference between the agreed-upon price and the market price at the time of settlement.
Futures contracts can be useful tools for hedging against risk or speculating on market movements. However, they can also be complex and risky, and should not be entered into lightly. If you are considering using futures contracts as part of your investment strategy, it is important to do your research and seek out expert advice before making any commitments.