What Are Futures?
What Are Options? -> What's Foreign Exchange Trading?
In finance, a futures contract, or simply futures, is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price.
Futures give the holder the obligation to buy or sell, which differs from an options contract, which gives the holder the right, but not the obligation. In other words, the owner of an options contract may exercise the contract, but both parties of a "futures contract" must fulfill the contract on the settlement date.
The seller delivers the commodity to the buyer, or, if it is a cash-settled future, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures position has to offset their position by either selling a long position or buying back a short position, effectively closing out the futures position and its contract obligations.
Futures are exchange traded derivatives. The exchange clearing house acts as counterparty on all contracts, sets margin requirements, etc.
Futures can be used either to hedge or to speculate on the price movement of the underlying asset. For example, a producer of corn could use futures to lock in a certain price and reduce risk (hedge). On the other hand, anybody could speculate on the price movement of corn by going long or short using futures.
In a nutshell
* The futures market is a global marketplace, initially created as a place for farmers and merchants to buy and sell commodities for either spot or future delivery. This was done to lessen the risk of both waste and scarcity.
* Rather than trade in physical commodities, futures markets buy and sell futures contracts, which state the price per unit, type, value, quality and quantity of the commodity in question, as well as the month the contract expires.
* The players in the futures market are hedgers and speculators. A hedger tries to minimize risk by buying or selling now in an effort to avoid rising or declining prices. Conversely, the speculator will try to profit from the risks by buying or selling now in anticipation of rising or declining prices.
* The CFTC and the NFA are the regulatory bodies governing and monitoring futures markets in the U.S. It is important to know your rights.
* Futures accounts are credited or debited daily depending on profits or losses incurred. The futures market is also characterized as being highly leveraged due to its margins; although leverage works as a double-edged sword. It's important to understand the arithmetic of leverage when calculating profit and loss, as well as the minimum price movements and daily price limits at which contracts can trade.
* Once you make the decision to trade in commodities, there are several ways to participate in the futures market. All of them involve risk - some more than others.
Commodity Futures Trading Commission (CFTC)
A U.S. federal agency established by the Commodity Futures Trading Commission Act of 1974. It ensures the open and efficient operation of the futures markets. There are five futures markets commissioners who are appointed by the president (subject to Senate approval).
The CFTC guards investors from manipulation, abusive trade practices, and fraud.
National Futures Association (NFA)
An independent self-regulatory non-profit organization that regulates the futures market.
The NFA began operating in 1982. Through the implementation and enforcement of regulatory programs, the NFA protects investors from fraudulent futures activities. It also provides arbitration and mediation services for resolving investor complaints. Since the NFA is independent, its regulations are unbiased towards any one member.
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