What Are Futures Contracts?

What Are Futures Contracts?

A futures contract is a standardized contract that is traded on a futures exchange that is regulated by the Commodity Futures Trading Commission (CFTC). There are many different types of futures products – agricultural, financial, precious metals, to name a few. Note that each type of futures contract has a defined set of specifications to which futures traders must adhere.

A futures contract requires the market participant to buy or sell an underlying instrument at a certain date in the future, at a specified price. It is important to note that a futures contract gives the holder the right to buy or sell the underlying instrument, but not the obligation to do so. Most futures contracts do not result in actual delivery or purchase of the underlying physical commodity or financial instrument and are offset prior to delivery.

In order to preserve the integrity of each transaction, an entity known as a “Clearing House” functions as the counter party to each transaction. The Clearing House provides other functions, such as margin requirements and settlement mechanisms, however is enough to know that the primary function is to ensure the integrity of each contract. This guarantee made possible by requiring Futures Commission Merchants (FCMs) to have adequate capital reserves deposited at the Clearing House.