Futures are financial contracts that obligate the buyer to purchase an asset or the seller to sell an asset at a predetermined price and specified date in the future. These contracts are standardized and traded on organized exchanges. Futures contracts cover a wide range of assets, including commodities (such as gold, oil, and agricultural products), financial instruments (such as stock indices and currencies), and even interest rates.
The main purpose of futures contracts is to manage price risk. They allow producers, consumers, investors, and speculators to lock in future prices for the underlying asset, providing a hedge against potential price fluctuations. For example, a farmer may use a futures contract to secure a fixed price for their crops before the harvest, protecting themselves from the risk of falling market prices. On the other hand, investors and speculators use futures contracts to speculate on the future direction of prices and potentially profit from price movements.
Futures trading involves 2 parties: the long position (the buyer) and the short position (the seller). When the contract reaches its expiration date, it can be settled in 2 ways: through physically delivering the underlying asset (in the case of commodities) or through a cash settlement, where the difference between the contract price and the market price gets paid.
Futures trading carries risks, as price movements can result in substantial gains or losses. Due to their leverage, small price fluctuations can have a significant impact on traders' positions. Therefore, futures trading requires careful consideration and risk management, making it more suitable for experienced investors and institutions with a good understanding of the market dynamics.