A futures contract is an agreement between two parties to buy or sell an asset. This contract executes at a certain time in the future for a certain price. Unlike forward contracts, futures contracts normally traded on an exchange. To make trading possible, the exchange specifies certain standardized features of the contract.
As two parties to the contract do not necessarily know each other. The exchange also provides a mechanism that gives the two parties a guarantee that the contract will be honored. The largest exchange on which futures contracts are traded in the Chicago Board of trade(CBOI) and Chicago Mercantile Exchange(CME).On these and other exchanges throughout the world, a very wide range of commodities and financial assets form the underlying assets in the various contracts.
One way in which a futures contract is different from a forward contract is that an exact delivery date is usually not specified. The contract referred to by its delivery months, and the exchange specifies the period during the month when delivery made. For commodities, the delivery period is often the entire month. The holder of the short position has the right to choose the time during the delivery period when it will make delivery.
How future contract works
The futures contract is an agreement to buy sell an asset at a certain time in the future for a certain price.
Future trading is to enter into contracts to buy or sell financial instruments dealing in commodities or other financial instruments.
Financial futures contracts exist to provide risk management to partial risk and uncertainty in the form of price volatility and opportunism are major factors giving rise to future trading. Future trading evolved out of autonomous forward contracting by merchants dealers and process.
Future v/s forward contract
1)Future contract in a competitive arena by “open outcry” of bids, offers, and amounts.
A forward contract done by telephone with participants generally dealing directly with broker-dealers.
2)Contract terms standardized with all buyers and sellers negotiating only with respect to price.
All contract terms are negotiated privately by the parties.
3)Participants include banks, corporations financial institutions,individual investors, and speculators.
participants are primarily institutions dealing with one other and other interested parties dealing through one or more dealers.
4)Long and short positions usually liquidated easily.
Forward positions not as easily offset or transferred to other participants.
5)Settlements normally made in cash, with only a small percentage of all contracts resulting in actual delivery.
The most transactions result in delivery.