If you are wondering “what are futures?”, you have found the right article. There’s no point in sugar coating it, futures are rather complex financial instruments. The basics are actually pretty straightforward, a future is a contract that obligates a buyer and seller to make a specified transaction at a specific price on a certain date. The implications and ramifications of futures, however, can be rather complex, especially for novice investors.
So what are futures? A future is a contract. It obligates two parties to carry out specific terms. The end date is sometimes called an expiration date, and at this pint the contract must be settled. A type of contract could be settled through the delivery of goods, or in cash (more on that later).
A futures contract is also transferable, so you can buy and sell the contracts themselves on the market. This means that the party obligated to buy under the future contract can sell the contract to another buyer. This buyer would then have to fulfill the terms of the contract or else sell the contract to another buyer. The seller can also sell his obligation to another seller.
Illustrating How Futures Works
Feeling a bit confused? Let’s use an example to illustrate how futures work and how you can make (or lose) money investing in them. Futures contracts can be drawn up for many different things. Often, futures are used in the commodities market, so let’s use a commodity as an example.
Let’s use a futures contract for heads of cattle. Let’s assume that a head of cattle is currently selling for $1,000 dollars, and futures for cattle for six months from now are selling for $900 dollars per head. You believe, however, that prices are set to rise substantially over the course of that time frame. You buy a contract for 10 cattle with an expiration date six months from now, paying $900 dollars for each cattle, or $9,000 overall.
Now let’s assume that cattle prices drop in the next week, with cattle now selling for $800 dollars per head. At the moment, you would be $1,000 dollars in the hole. People looking to buy the contract off you would likely have a negative outlook. If you wanted to sell the future contract, you would most likely lose money since prices went south.
Let’s assume you hold onto the contract, however, and your intuition proves to be correct. Prices rise gradually over time, and on the expiration date, cattle prices have risen to $1,200 dollars per head. You would then earn the extra money, which would amount to $3,000 dollars! Given how much prices for commodities can fluctuate, there are many opportunities to earn and lose money.
Some Details Regarding Futures
Technically, a future is a contract for the delivery of a good or asset, but futures are rarely settled in assets. Instead, the buyer and seller normally settle with cash. This means that the seller will pay the buyer the difference if prices rise. If prices drop, the buyer would have to pay the seller the difference. At any point before the expiration date, you could sell the contract. At that point, investors looking to buy the contract off you would be trying to predict the final value on the expiration date.
Besides commodities like cattle, corn, and gold, you can also buy futures contracts for stocks, stock indexes, and other investment vehicles. Investors like investing in futures because markets are highly speculative and volatile. This means that there are a lot of opportunities to produce profits, but also a risk of losing money.
We hope this answers the question “what are futures”. If you are considering trading in futures, you should know that markets are highly speculative. This means that there is a lot of potential to make profits, but risks are also higher. No matter what or how you choose to invest, make sure you consider all of the associated risks and keep yourself well covered.