Futures

A futures contract is a legally binding agreement to buy or sell a specific commodity, such as soybeans, or financial instrument, such as silver or the Euro, on a particular date in the future at an agreed upon price. Futures belong to a category of financial instruments known as derivatives, because their prices are derived from the value of other, underlying instruments, items, or products. In the case of futures, commodities of various kinds are the products underlying the contracts.

From forward to future

Futures developed from forward contracts, originally used by commodity producers — corn farmers for example — who wanted to lock in the price they were to be paid for corn when it was harvested some months later. The object was to reduce risk. With the contract in hand, the farmer could be protected if corn prices dropped.

Futures contracts formalized the forward contract process, imposing standard contract terms for grade — or quality — quantity, time, and location. With the imposition of standard delivery specifications, it became possible to trade contracts on an organized exchange, creating a futures marketplace.

Buying and selling a futures contract does not transfer ownership, as buying or selling a stock does. Rather, it spells out the terms under which the underlying commodity is to be purchased or sold at a later date.