The Basics of Futures Contracts

A futures contract, which is often referred to simply as futures, is a special type of standardized contract that is traded on a futures exchange. When trading futures, you are actually buying or selling it for a specific date in the future at a specific price.

The date that is set for the futures contract is referred to as a delivery date or as a final settlement date, while the pre-set price is referred to quite simply as the futures price. The price of the underlying asset, on the other hand, is referred to as the settlement price.

When you trade futures contracts, you are actually obligated to buy or sell the contract on the specific date. In this way, futures contracts are different from options contracts because those that hold options contracts have the right to buy or sell the contract but are not obligated to do so.

Any time a futures contract is set into motion, there are two parties involved: the buyer and the seller. As such, both the buyer and the seller are obligated to fulfill their end of the bargain. Therefore, even if the contract no longer seems like a good buy when the delivery date rolls around, the buyer must still complete the purchase. Similarly, if the seller decides that he or she would like to hang onto the contract, he or she does not have this option.

Once the settlement date comes around, the seller is obligated to deliver the futures contract to the buyer. If the futures contract agreement is a cash-settled future, on the other hand, then the cash is transferred from the person that experienced a loss to the person who made the profit.

If the person holding the futures contract wishes to get out of the deal before the settlement date has been reached, he or she does have a few available options. One option the holder has is to offset the position by selling a long position. The other option is to purchase a short position. By doing so, the holder essentially closes out the futures position and is free from contract obligation.

Futures are liquid assets and this liquidity is made possible by the fact that it is highly standardized. There are several different methods by which the futures can remain standardized. Some of these include specifying:

• The grade of the deliverable
• The delivery month
• The last trading date
• The underlying instrument or asset
• The type of settlement, such as whether it is a physical or cash settlement
• The amount of the underlying asset
• The currency used to quote the futures contract
• The minimum price fluctuation that is permissible

By specifying these characteristics, the liquidity of the futures is maintained, making it a highly sought commodity for many investors.

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More on Futures:

• Pricing
• Futures and Forward Contracts
• Future Contracts and Settlement
• Margins

Some interesting books on the subject of Futures:

• The Futures Game: Who Wins, Who Loses, & Why
  (by Richard J. Teweles and Frank J. Jones)
  
  
• Futures & Options For Dummies
  
  
• Starting Out in Futures Trading
  (by Mark Powers)

Compare prices of the above books at Affordabook.com.

Looking to invest some of the money you gained via futures investing? Why not try your hand at real estate investing, like home foreclosures, for example.

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