What Exactly are Futures?

What Exactly are Futures

Futures are a sort of derivative contract in which the buyer and seller agree to buy or sell a specified commodity asset or security at a predetermined price at a future date. Futures contracts, or simply “futures,” are traded on futures exchanges such as the CME Group and require a futures-approved brokerage account.

A futures contract, like an options transaction, involves both a buyer and a seller. When a futures contract expires, the buyer is bound to acquire and receive the underlying asset, and the seller of the futures contract is obligated to provide and deliver the underlying item, unlike options, which can become worthless upon expiration.

Uses for futures

Hedging (risk management) and speculating are the two most common uses of futures in investment.

Hedging with futures

Institutional investors and companies typically use futures contracts bought or sold with the intent to receive or deliver the underlying commodity for hedging purposes, often as a way to help manage the future price risk of that commodity on their operations or investment portfolio.

Speculating with futures

Futures contracts are often liquid, meaning they can be purchased and traded up to the expiration date. This is a critical characteristic for speculative investors and traders who do not own or seek to own the underlying commodity. They can buy or sell futures to express a view on the direction of a commodity market and potentially benefit from it. They will then buy or sell an offsetting futures contract position before to expiration to eliminate any obligation to the actual commodity.

What are the Benefits of Trading Futures?

Individual investors and traders regularly use futures to speculate on the underlying asset’s future price movement. They try to make money by predicting where the market for a particular commodity, index, or financial product will go. Futures are also used by some investors as a hedge, often to assist offset future market fluctuations in a certain commodity that could affect their portfolio or business.

Stocks and exchange-traded funds (ETFs) can, of course, be used to speculate on or hedge against future market movements. They all come with their own set of hazards to consider, but the futures market has certain particular advantages that the stock market does not.

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