If you`re new to the world of trading, you may have heard the term “futures contract” thrown around. But what exactly is a futures contract? At its most basic level, a futures contract is a legally binding agreement between two parties to buy or sell a particular asset (such as a commodity, currency, or stock index) at a predetermined price and date in the future. Let`s delve a little deeper to gain a better understanding.
Firstly, let`s discuss the parties involved. The buyer of a futures contract is said to be “long”, while the seller is said to be “short”. When a long position is opened, the buyer is agreeing to purchase the asset at a future date and at a set price. Conversely, when a short position is opened, the seller is agreeing to sell the asset at a future date and at a set price.
Now, why would someone want to enter into a futures contract? There are a few reasons. Firstly, futures contracts allow for price discovery. They provide a transparent price for the asset being traded, which can help buyers and sellers alike make more informed trading decisions. Additionally, futures contracts can be used to manage risk. For example, if a farmer is concerned that the price of wheat may drop in the future, they could sell wheat futures contracts to lock in a price and protect themselves against losses.
It`s important to note that futures contracts are different from options contracts, which give the buyer the right (but not the obligation) to buy or sell an asset at a predetermined price and date. With a futures contract, both parties are obligated to fulfill the terms of the agreement.
In summary, a futures contract is an agreement between two parties to buy or sell an asset at a predetermined price and date in the future. They can be used to facilitate price discovery and manage risk. If you`re interested in trading futures contracts, it`s important to do your research and fully understand the risks involved before getting started.