What is Futures Contract?
Definition
A futures contract is a standardized agreement to buy or sell an asset at a predetermined price on a specific future date. Unlike options, futures obligate both parties to complete the transaction. They are used for hedging, speculation, and price discovery.
Detailed Explanation
Futures are traded on exchanges (CME, ICE, CBOT) and cover a wide range of assets: stock indices (S&P 500, Nasdaq), commodities (oil, gold, wheat), currencies, interest rates, and even volatility (VIX futures). Each contract specifies the asset, quantity, delivery date, and minimum price increment.
Futures use margin (a performance deposit, typically 5-15% of contract value) rather than full payment, providing significant leverage. A $10,000 margin deposit might control $100,000 worth of an asset. This leverage amplifies both gains and losses.
Daily settlement (mark-to-market) means gains and losses are credited or debited to accounts each day. If losses reduce margin below the maintenance level, a margin call requires additional deposits.
Futures serve critical economic functions: farmers hedge crop prices, airlines hedge fuel costs, and portfolio managers hedge market exposure. The futures market also provides price discovery—futures prices often lead cash market prices because they are easier to trade in large quantities.
Most futures contracts are closed before delivery through an offsetting trade. Physical delivery occurs in a small percentage of commodity contracts.
Frequently Asked Questions
How are futures different from options?
What are stock index futures?
Can individual investors trade futures?
Related Terms
Volatility
Volatility measures the degree of variation in a stock's price over time. Higher volatility means larger and more frequent price swings, indicating greater uncertainty and risk. It is commonly expressed as the annualized standard deviation of returns.
Margin Trading
Margin trading involves borrowing money from a broker to purchase securities, using the purchased securities as collateral. It amplifies both gains and losses, allowing investors to control larger positions than their cash alone would permit.
Hedging
Hedging is an investment strategy designed to reduce the risk of adverse price movements in an asset. It typically involves taking an offsetting position in a related security, such as options, futures, or inverse ETFs.
Options
Options are financial contracts that give the buyer the right, but not the obligation, to buy (call) or sell (put) an underlying asset at a specified price (strike) before a specified date (expiration). They are used for speculation, hedging, and income generation.
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Disclaimer: The information on this page is provided for educational and informational purposes only and does not constitute investment advice. AI-generated analysis may contain errors or inaccuracies. Always conduct your own research and consult a qualified financial advisor before making investment decisions.
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