Futures contract
Standardized contract to buy or sell at a future date.
A futures contract is a standardized legal agreement to buy or sell a specific commodity or financial instrument at a predetermined price, with delivery and payment occurring at a specified future date. Crucially, the two parties to the contract are not known to each other, as trading occurs on a futures exchange that acts as a marketplace. The contract’s value is derived from the underlying asset, making it a type of derivative. The buyer holds a long position, while the seller holds a short position. To guard against the risk of one party defaulting if the price moves unfavorably, both parties must deposit a performance bond, known as margin, with a trusted third party. This margin, often a percentage of the contract’s value, fluctuates based on market volatility; for instance, in gold futures, it can range from 2% to 20%. The contract is marked to market daily, meaning the exchange transfers money from the losing party’s margin account to the winning party’s account to reflect daily price changes. If the margin falls below a required level, a margin call forces the account holder to replenish it. On the delivery date, the amount exchanged is the spot value, as all gains or losses have already been settled through this daily process.
Historically, the first known use of a futures-like arrangement is attributed to Thales of Miletus, who secured olive presses ahead of an expected bumper crop. The Dōjima Rice Exchange in Osaka, established in 1697, is considered an early futures exchange, created to help samurai paid in rice stabilize their income after poor harvests. The Chicago Board of Trade listed the first standardized exchange-traded forward contracts in 1864, based on grain, which were called futures contracts. This innovation spread globally; by 1875, cotton futures were traded in Bombay, later expanding to edible oilseeds, jute, and bullion. In the 1930s, wheat accounted for two-thirds of all futures trading. Financial futures emerged in 1972 with the creation of the International Monetary Market, which launched currency futures, followed by interest rate futures on U.S. Treasury bills in 1976 and stock market index futures in 1982. Today, futures are used for hedging price risk—for example, fixing a foreign currency exchange rate in advance—and for speculation, where traders profit from correctly predicting price movements. Retail traders increasin
- field
- Finance
- known_for
- Standardized exchange-traded forward contracts for hedging and speculation
- first_financial_futures_exchange
- 1972, International Monetary Market (IMM) by Chicago Mercantile Exchange
Lore & Background
Futures contracts are standardized legal agreements traded on exchanges, obligating the buyer (long position) or seller (short position) to transact an underlying asset—such as a commodity, currency, or financial instrument—at a predetermined price on a specified future delivery date. The contract’s value derives from the underlying asset, making it a derivative. To reduce counterparty risk, both parties deposit a performance bond called margin, often a percentage of the contract’s value (e.g., 2% to 20% for gold, depending on spot market volatility). The exchange marks the contract to market daily, adjusting margin accounts to reflect price changes; if an account falls below a required threshold, a margin call forces replenishment. On the delivery date, only the spot value is exchanged, as prior gains or losses have already been settled. The first standardized futures contracts emerged in 1864 at the Chicago Board of Trade for grain trading, followed by cotton futures in Bombay by 1875, and later contracts for edible oils, jute, and bullion. Financial futures began in 1972 with currency futures at the International Monetary Market, expanding to interest rate futures on U.S. Treasury bills in 1976 and stock market index futures in 1982. Futures are used for hedging price risk—for instance, locking in exchange rates for future foreign currency receipts—and for speculation, where traders profit from predicted price movements, potentially smoothing commodity supply over time.
Reader's Guide
Futures contracts are significant because they provide a mechanism for mitigating price risk and enabling speculation. Their original use allows parties to fix prices or exchange rates in advance for future transactions, which is advantageous for hedging against unfavorable movements. They also offer opportunities for speculation: a trader predicting price direction can contract to buy or sell at a price that yields profit if correct, and such speculation can help distribute commodities over time—saving during surplus and selling during need. The introduction of financial futures in 1972, including currency futures, interest rate futures, and stock market index futures, expanded their role. Retail traders increasingly use futures alongside options to hedge, manage leverage, and scale entries in volatile markets. Even organ futures have been proposed to increase the supply of transplant organs. The futures exchange requires both parties to post margin—a performance bond—to guarantee the agreement, and positions are marked to market daily to mitigate default risk. The clearing house becomes buyer to each seller and seller to each buyer, enabling traders to transact without due diligence on counterparties. Margin requirements are set by the exchange and may be waived for hedgers with physical ownership or spread traders with offsetting positions.
Did You Know?
- The first historically known creation and use of futures may have been Thales of Miletus with his purchase of olive presses before an expected bumper crop of olives.
- In the 1930s two-thirds of all futures was in wheat.
Frequently Asked Questions
What is a futures contract in finance?
A futures contract is a standardized legal agreement in which two parties commit to buying or selling a specific asset at a set price on a predetermined future date. It is traded on an organized exchange, and the counterparties are typically not known to each other in advance.
How does a futures contract differ from a forward contract?
While both lock in a future price, a futures contract is standardized and exchange-traded, whereas a forward is a private, customized bilateral agreement. The exchange-based structure gives futures greater liquidity and lower counterparty risk.
When and where did financial futures first appear?
The first dedicated financial futures exchange was launched in 1972 when the Chicago Mercantile Exchange created the International Monetary Market. This marked a major shift from commodity-only futures to instruments such as currency and interest-rate contracts.
What are the two primary purposes of a futures contract?
Market participants use futures contracts either to hedge against unwanted price swings in an underlying asset or to speculate on future price movements for profit. In both cases, the contract's value is derived entirely from the performance of that underlying asset.
Why is a futures contract classified as a derivative?
A futures contract is called a derivative because it carries no standalone value; its worth is entirely tied to the price of the underlying commodity or financial instrument. The contract itself is a legal wrapper whose payoff depends on how that underlying asset moves.
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