Futures contracts

In finance, a futures contract (more colloquially, futures) is a standardized forward contract which can be easily traded between parties other than the two initial parties to the contract. The parties initially agree to buy and sell an asset for a price agreed upon today (the forward price), with delivery and payment occurring at a future point, the delivery date. Because it is a function of an underlying asset, a futures contract is a derivative product.

Contracts are negotiated at futures exchanges, which act as a marketplace between buyers and sellers. The buyer of a contract is said to be long position holder, and the selling party is said to be short position holder. As both parties risk their counter-party walking away if the price goes against them, the contract may involve both parties lodging a margin of the value of the contract with a mutually trusted third party. For example, in gold futures trading, the margin varies between 2% and 20% depending on the volatility of the spot market.

The first futures contracts were negotiated for agricultural commodities, and later futures contracts were negotiated for natural resources such as oil. Financial futures were introduced in 1972, and in recent decades, currency futures, interest rate futures and have played an increasingly large role in the overall futures markets.

The original use of futures contracts was to mitigate the risk of price or exchange rate movements by allowing parties to fix prices or rates in advance for future transactions. This could be advantageous when (for example) a party expects to receive payment in foreign currency in the future, and wishes to guard against an unfavorable movement of the currency in the interval before payment is received.

However, futures contracts also offer opportunities for speculation in that a trader who predicts that the price of an asset will move in a particular direction can contract to buy or sell it in the future at a price which (if the prediction is correct) will yield a profit.

The Dutch pioneered several financial instruments and helped lay the foundations of modern financial system. In Europe, formal futures markets appeared in the Dutch Republic during the 17th century. Among the most notable of these early futures contracts were the tulip futures that developed during the height of the Dutch Tulipmania in 1636. The Dōjima Rice Exchange, first established in 1697 in Osaka (Japan), is considered by some to be the first futures exchange market, to meet the needs of samurai who—being paid in rice, and after a series of bad harvests—needed a stable conversion to coin.

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Wikipedia