Futures contracts are very important for the modern economy. In fact, they were important for older economies as well. Some even believe it was the first financial contract out there. These types of contracts are most important for commodity markets, and we will soon see why. So, in this article, we will have a glance at what futures contracts are.
The main outline
The main idea about futures contracts is that they are a promise to sell an asset at a later date. They have a set price and a set date for the transaction. This means that sudden price volatility cannot affect the price of an asset. So, both parties should feel defended against sudden changes in opinion.
This is most relevant for industries with continued output. If you are continuously producing, say, corn, you want to make sure someone will be there to buy your product.
One cannot usually set the contact at an exchange. It can set up all the details you want it to quite easily. However, these contracts are highly regular, and not subject to much change. A trader can set up their own futures contracts at their own risk.
Speculators and hedgers also use futures, however. Because they do not need to worry about what the future price will be, they can speculate about what people will think it will be.
Let’s have a quick look at a real-world, normal futures trade. An oil produced has a load of supply they are always producing. They find a buyer who wants their product. The buyer can then get the best possible price for their oil barrels. The oil producer then gives over the oil to the buyer at the set date. Both parties know ahead of time what they’re getting into. Therefore, no-one leaves feeling cheated.
Overall, futures contracts minimise the risk for making any sort of trade.