A future is a contract between two parties to purchase a commodity or other asset at a later point of time, but for a price agreed on today.

    In a futures contract, the item being purchased is typically for a standard quality and quantity, with both parties agreeing to a price on the spot (typically called the “strike price”), with delivery at a specific future date (“delivery date”).

    The buyer of the contract is obligated to buy on the delivery date and the seller of the contract is obligated to sell. This is the key difference to options, where only seller is committed to take the trade, but the buyer has the option not to exert the option.

    Futures exchange

    Futures are traded on a futures exchange, which means the futures market is a centralised marketplace for futures traders around the world.

    Initially, the futures market was created by farmers and merchants. Today, futures contracts can be bought for almost any commodity or financial instrument.

    Rather than trade the physical commodity itself, the majority of futures traders buy and sell futures contracts on a speculative basis. They are not interested in the actual delivery of the goods.

    Companies that rely on purchasing commodities may use futures contracts because they do actually take delivery and need price stability to operate profitably.

    The seller, meanwhile, has sold their commodity at a guaranteed price, thus avoiding possible unfavourable fluctuations in the market price at the time of the delivery date.

    Example: The seller is offering 1,000 tonnes of wheat for sale. The wheat is still growing and won’t be harvested until several months later. The buyer and seller agree on a strike price of $50 a tonne – the price, therefore, is $50,000. The delivery date is 12 weeks later, after harvest. On the delivery date, the buyer pays the agreed strike price and the seller hands possession of the 1,000 tonnes of wheat to them.