Futures are financial contracts that obligate the buyer to purchase, or the seller to sell, an underlying asset at a predetermined price on a specified future date. Futures contracts are commonly used to trade commodities (such as oil, gold, and wheat) and financial instruments (such as stock indices, currencies, and interest rates). Unlike spot markets, where the transaction occurs immediately, futures contracts focus on price movements over time.

How Futures Work

A futures contract specifies:

1. The asset (e.g., gold, oil, or a stock index).
2. The quantity of the asset.
3. The delivery date in the future.
4. The agreed-upon price at which the transaction will take place.

For example, if you buy a futures contract for oil at $75 per barrel with a delivery date in three months, you are agreeing to buy oil at that price regardless of the market price at the contract’s expiration. Conversely, if you are selling, you commit to delivering oil at that price. Many futures contracts are cash-settled, meaning no physical delivery occurs—the difference between the contract price and the actual market price is settled in cash at expiration.

Types of Futures Contracts

• Commodity Futures: Contracts for physical goods like oil, gold, wheat, or natural gas.
• Financial Futures: Contracts on financial assets such as stock indices, interest rates, or currencies.

Who Uses Futures?

1. Hedgers: Businesses or investors who want to protect themselves against price fluctuations. For example, an airline might buy oil futures to lock in fuel costs and hedge against rising prices.
2. Speculators: Traders who aim to profit from price movements in the underlying asset. They take on the risk in hopes of capitalizing on future price changes.

Leverage

Futures contracts typically involve leverage, allowing traders to control large positions with a smaller amount of capital. This can magnify both potential profits and losses, making proper risk management essential.

Risks of Futures Trading

• Leverage Risk: As with many derivatives, leverage in futures trading can amplify both gains and losses. Even a small adverse price movement can lead to substantial losses.
• Market Volatility: Futures markets, especially commodities, can be highly volatile due to external factors such as weather, geopolitical events, or supply-demand shifts.
• Expiration Risk: Futures contracts have an expiration date, so traders need to close or roll over positions before expiration or risk having to take physical delivery of the underlying asset.

Conclusion

Futures are powerful tools for hedging and speculation, offering opportunities to profit from price movements in commodities and financial markets. However, they carry significant risks, especially due to leverage and market volatility. Futures trading requires a solid understanding of the markets and proper risk management to be successful.