How do futures contracts work?
Futures contracts are standardised to specify the quality and quantity of the underlying asset. When a trader buys a futures contract they are taking on the obligation to buy the underlying asset, at the agreed price, when the futures contract expires. And when a trader sells a futures contract, they would be obliged to sell the asset for the agreed price at the expiration date.
While some futures will require the physical asset itself to change hands, others can be settled in cash. When traders settle in cash, they exchange the price dictated in the contract, which could differ from the market’s current price.
All futures contracts have an expiry date: the date at which the underlying asset has to be delivered in the future. This differs from the ‘spot’ price, which is the price of a market if the trade were to be completed that day.
Commodity producers often use futures contracts to guarantee the price of their product ahead of sale, as they present a way to lock in the price of an asset for the long term, keeping prices stable. But most retail traders buy futures with the intention of selling them again at a higher price and making a profit. They are often used to hedge against other trades, or purely for speculation.