Futures are standardized forward contracts in which two parties agree to trade a specific underlying asset (such as commodities, stock indices, or currencies) at a predetermined price and time in the future. The buyer commits to purchasing the underlying asset at this date, and the seller commits to delivering or selling it—regardless of the market price at that time. Therefore, this is referred to as an 'unconditional forward transaction'.
Futures are traded on specialized futures exchanges and are heavily regulated and standardized: quantity, quality, delivery location, and expiration date are strictly prescribed and not individually negotiable. The price is determined at the time of purchasing the contract, but the actual execution occurs later.
There are two main types:
• Commodity Futures: relate to commodities (e.g., oil, wheat).
• Financial Futures: relate to financial products (e.g., stock indices, interest rates).
An important term in futures trading is margin: when concluding the contract, only a fraction of the total value (the 'security deposit') needs to be provided. This makes futures speculative, as high profits, but also high losses, are possible with a small capital investment.
Originally, futures were used for hedging against price fluctuations, but today they are also used for speculation on price developments. Upon expiration, there is either a physical delivery of the underlying asset or a cash settlement, although most contracts are closed out beforehand.
