What is a futures contract and what are its uses?
Learn about futures contracts and how they help a wide variety of professionals achieve financial success and avoid volatile price fluctuations.
Investors have many strategies and options for buying, selling, and profiting on the stock market. Futures contracts are one of the most popular options. What are futures contracts? Learn what they are and how to use them with the following FAQs.
What is a futures contract?
A futures contract definition can seem complicated, but the basic premise of futures contracts is simple. Companies and individuals use futures to secure the current cost of something up to a certain date and time in the future. These contracts can be used for stock markets, currency values, and even interest rates.
Futures and forward contracts both enable people to counteract or assume the risk of the price change of an asset over a period of time. While the two share similarities, a futures contract is different in that it is a legally binding agreement to sell or buy an asset during a specific time. The other differentiator is that the transaction is organized through a futures exchange.
How do futures contracts work?
Futures lock in the current price of something that you’ll buy or sell in the future. For example, some assets like oil, gas, or gold have volatile prices, meaning the cost per unit of each fluctuates wildly over time. With a futures contract for oil, for example, you can secure a price in the present for the oil you want to buy later.
If you’re the seller, a signed futures contract means you’re legally obligated to provide an asset on a certain date in the future. And if you’re the buyer, the signed contract means you have to buy that asset on that date. Now that you know how this type of contract works, let’s explore some tips on writing contracts using a futures contract example.
Futures contract example.
Let’s say that a company produces a commodity like corn. Over the next year, the company plans to grow and produce one million bushels of corn to sell on the market. With a futures contract, a buyer could agree to pay $4 a bushel for one million bushels of corn delivered on October 30 of the following year.
The buyer and seller agree to the set price, regardless of the average price of corn on the date of the contract’s execution. On October 30, corn could be $6 a bushel or $3 a bushel. Futures allow a seller to do a future deal at current market prices.
What’s the difference between options vs futures contracts?
Both options and futures contracts are standard forms of trading agreements. Futures specify a specific date when an asset must be bought or sold, while an options contract can be used any time before its expiration date.
In a futures contract, both the buyer and seller must complete the transaction. With an options contract, the buyer has the right to exercise the option but isn’t obligated to complete the transaction.
Futures contracts can be long term or short term and can benefit both buyers and sellers. They’re often used to:
- Plan out budgets in advance
- Hedge price fluctuations
- Leverage price fluctuations for profit
Manage your contracts and investments with ease.
Whether you’re an investor, a manufacturer, or a farmer, futures contracts could help you plan for your financial future and mitigate risks over time. Explore everything you can do from managing and writing contracts to requesting signatures and signing documents with Adobe Acrobat for business today.