A futures contract is a standardized agreement between two parties to buy or sell an underlying asset at a specified price and at a specified date in the future. Futures contracts are traded on organized exchanges and are used to manage price risks associated with the underlying asset.
Here are some key aspects of a futures contract:
Parties involved: The two parties involved in a futures contract are the buyer and seller. The buyer is the party who agrees to buy the underlying asset at a future date, and the seller is the party who agrees to deliver the underlying asset at a future date.
Underlying asset: The underlying asset can be a physical commodity, financial instrument, or currency. Some examples include oil, gold, stock indices, and foreign currencies.
Contract size: The contract size for a futures contract is predetermined and standardized by the exchange on which it is traded. For example, a futures contract for crude oil may be for 1,000 barrels of oil.
Expiration date: The expiration date is the date on which the contract expires. On the expiration date, the buyer is obligated to take delivery of the underlying asset, and the seller is obligated to deliver the underlying asset.
Price: The price of the underlying asset is agreed upon at the time the contract is signed. This is known as the futures price. The futures price is determined by the market and is influenced by supply and demand factors, interest rates, and the time until the delivery date.
Margin: In order to enter into a futures contract, both the buyer and seller are required to deposit a margin with the exchange. The margin serves as collateral and is used to cover any losses that may occur due to changes in the market price of the underlying asset.
Mark-to-market: Futures contracts are marked-to-market on a daily basis. This means that the gains or losses incurred by each party are calculated on a daily basis and settled on a daily basis.
Overall, futures contracts are a useful tool for managing price risk associated with an asset. They provide a standardized way for buyers and sellers to agree on a price for a future transaction, which can be useful in managing uncertainty in the market. However, it is important to understand the risks associated with futures contracts, including the potential for losses due to changes in the market price of the underlying asset and the obligation to take delivery of the underlying asset on the expiration date.