Futures contract

People make special deals to trade things later.

These deals can be for things like grain or oil. Long ago, people used them for rice. This helped them know how much money they would get.

Some people use these deals to guess prices. They try to make a profit. This can help move food to where it is needed.

To keep things safe, people give money to a third party. This money is like a deposit. It makes sure everyone keeps their promise.

These deals help people plan for the future. It is a way to manage risk.

A futures contract is a special legal deal. It is an agreement to buy or sell something later. The price is set today. This price is for a date in the future. People call this the delivery price. The date when the trade happens is the delivery date.

These deals are often for things like oil or grain. They can also be for money or stocks. People use these deals to manage risk. This helps them plan for price changes. Some people also use them to guess future prices. If their guess is right, they can make a profit. This can help move goods to where they are needed most.

To keep these deals safe, people use a margin. A margin is a deposit of money. Both the buyer and the seller give this money to a trusted third party. This makes sure everyone keeps their promise. If the price changes a lot, the exchange checks the money every day. This helps prevent anyone from breaking the deal.

A futures contract is a special legal agreement between two people. These two people might not even know each other yet. They agree to buy or sell something at a set price. This price is called the forward price or delivery price. The trade does not happen right away. Instead, it happens on a specific day called the delivery date. Because the value of the deal comes from something else, it is called a derivative.

People use these contracts in two main ways. Some use them for hedging. Hedging is a way to protect against price changes. For example, a person might want to fix a price today for a foreign currency they will receive later. Other people use them for speculation. Speculators try to guess if a price will go up or down. If their guess is right, they can make a profit. This can even help move goods like food to where they are needed most.

These markets have a very long history. Some people believe the first futures exchange was in Osaka, Japan. It was called the Dōjima Rice Exchange and started in 1697. Samurai used it because they were paid in rice. They needed to turn that rice into coins. Later, the Chicago Board of Trade listed the first standardized contracts in 1864. These early deals were mostly about trading grain.

Many different things are traded in these markets today. In 1875, people in Bombay, India, traded cotton futures. By the 1930s, wheat made up two-thirds of all futures. In 1972, the International Monetary Market launched financial futures. This allowed people to trade currencies. Later, they added interest rate futures in 1976. By 1982, they even added stock market index futures. Today, traders use many different types of these contracts.

To keep everyone safe, these deals use something called a margin. A margin is a security deposit of money. Both the buyer and the seller give this money to a trusted third party. This helps prevent people from breaking their promises. The exchange checks the money every day. This process is called marking to market. If the money in an account gets too low, the person gets a margin call. They must then add more money to keep the deal going.

A futures contract is a standardized legal agreement used in finance. It involves a buyer and a seller agreeing to trade an asset at a specific price. This price is called the forward price or delivery price. The trade does not happen immediately. Instead, the exchange of the asset and the payment occurs on a set delivery date. Because the value of the contract comes from an underlying asset, it is known as a derivative.

There are two main roles in these transactions. The buyer of the contractual right is called the long position holder. The person selling the contract is the short position holder. These parties often use futures for two different reasons: hedging or speculation. Hedging is used to manage price risk. For example, a person might use a contract to fix a currency rate. This protects them from unfavorable price movements before they receive a payment. Speculators, however, trade to profit from price changes. They try to predict if a price will rise or fall. If their prediction is correct, they earn a profit. This can even help distribute commodities like food more effectively during times of surplus or need.

To make sure both parties follow the rules, they must use a margin. A margin is a security deposit of money held by a trusted third party. This deposit acts as a performance bond to prevent a party from reneging on the deal. For example, gold futures trading might require a margin between 2% and 20% of the contract value. This amount depends on the volatility of the spot market. The exchange also uses a process called marking to market. This means the contract is re-evaluated every day based on current prices. The difference between the agreed price and the daily price is settled daily. This is known as the variation margin. If an account balance falls too low, the exchange issues a margin call. The owner must then add more money to the account.

To further reduce risk, regulated exchanges use a clearing house. The clearing house acts as the buyer to every seller and the seller to every buyer. This ensures that if one person fails to pay, the clearing house assumes the risk. This system allows traders to transact without needing to perform deep research on the person they are trading with. Some traders, like hedgers with physical ownership of a commodity, may have certain margin requirements waived or reduced. Other types of margins exist, such as the initial margin used to start a position. The exchange sets this amount based on estimated daily price changes. There is also a maintenance margin, which is the minimum amount a customer must keep in their account.

Futures markets have a long and interesting history. Some consider the Dōjima Rice Exchange in Osaka, Japan, to be the first futures exchange. It was established in 1697 to help samurai. They were paid in rice and needed a stable way to convert it into coin after bad harvests. Later, the Chicago Board of Trade (CBOT) listed the first standardized exchange-traded contracts in 1864. These were based on grain trading. By 1875, cotton futures were being traded in Bombay, India. This led to trades in oilseeds, jute, and bullion. In the 1930s, wheat accounted for two-thirds of all futures trading.

The market changed significantly in the 20th century. In 1972, the Chicago Mercantile Exchange created the International Monetary Market (IMM). This was the world's first financial futures exchange. It launched currency futures, which allowed for trading different types of money. In 1976, the IMM added interest rate futures for US treasury bills. By 1982, they added stock market index futures. A stock future is a cash-settled contract based on the value of a market index. These are considered high-risk instruments. They are also used as indicators to help people understand market sentiment.

Contracts eventually reach a point called expiry or expiration. This is the day a specific delivery month stops trading. On this day, the final settlement price is determined. For many index and interest rate futures, this happens on the third Friday of certain months. During this time, traders may "roll over" their positions to the next contract. There are two ways to finish a contract: physical delivery or cash settlement. In physical delivery, the seller actually provides the specified amount of the asset. In other cases, the contract is settled through payments. Even unique ideas have been suggested, such as organ futures to help increase the supply of transplant organs.