Futures

Futures are exchange-traded forward contracts. Under these contracts, two parties agree to buy or sell a specific underlying asset at a predetermined time in the future at a price agreed upon today. Possible underlying assets include commodities, currencies, stock indices, or bonds. Unlike options, futures impose an unconditional obligation to fulfill the contract on both parties.

Standardization in terms of quantity, quality, and delivery date enables liquid trading on futures exchanges. To hedge against the risk of non-performance, market participants must post collateral (margins). Gains and losses are settled daily via mark-to-market accounting. Futures are primarily used to hedge against price fluctuations or to speculate on market movements. Since often only a fraction of the contract value needs to be deposited as collateral, a leverage effect arises that increases both potential returns and the risk of loss. Physical delivery of the underlying asset is possible; in practice, however, cash settlement or the closing out of the position before maturity usually occurs.