Understanding the Futures Contracts

Futures market is a marketplace where buyers and sellers engage in commodity selling contracts. Although the futures contracts state the price and when it is paid as well as the date of delivery of the products, almost all futures contracts end without the actual delivery of commodities. The futures contract is an agreement between two parties.

One party takes a short position and this is the party who agrees to deliver a commodity and a long position is taken by the other party who agrees to receive a commodity. The price of futures is represented by an agreed-upon price of the commodity in question. A financial instrument may also be used to determine the price of the commodity.

The profits and losses of futures contracts largely depend on the daily price movements that are witnessed in the market. The profits and losses are calculated on daily basis. Unlike the stock markets, the futures positions are adjusted or settled on a daily basis and this means that profits and losses are deducted or credited on the traders’ accounts on a daily basis based on the movement of the price as agreed upon in the contract.

Since the accounts of the parties engaged in a futures contract are adjusted every day, this means that most transactions in this market are settled in cash. What happens is that the actual physical commodity is bought and sold in the cash market but not in the futures market. Depending on how the prices change every day, when the two positions decide to close their contract, one will have lost and the other gained but this depends on how the prices have changed over that period.

In the real sense, none of the parties actually go to the market to buy or sell these commodities and this means they only act as speculators of the price movements. This is how the futures contracts are derived. The futures contract is more like a financial position and the position takers are actually speculators.

The short speculator is the one who agrees to deliver the commodity and the long speculator is the one who agrees to receive the commodity. But because neither of these parties will go to the market to buy or sell the commodity even after the contract expires, it means that all the deals are settled in cash.

Futures markets are important economic tools since they help determine the supply and demand of commodities today and in the future. The continuous flow of information from around the world affects the prices. Factors like war, weather changes, debt defaults, government regulations on major currencies as well as crop reports all affect the market prices.

It is this kind of information and the way people tabulate and absorb it, which constantly keeps on influencing the price of the commodities in the futures market. This is a process known as price discovery. Because the price of commodities is pre-set, this reduces the risks. The traders know how much they will need to buy and sell.