A Futures contract is an agreement to buy or sell a commodity at a specific price on a future date, regardless of the prevailing market price at the time of the trade. The underlying asset can be physical commodities like oil or metals, financial instruments, or stock indexes like the S&P 500. To make trading easier, all futures contracts are standardized for quality and quantity (for example, one West Texas Intermediate crude oil futures contract equals 1,000 barrels of oil).
Investors use futures to hedge against big price swings up or down – they’re popular among companies that rely on commodities like wheat or corn for their business and want to protect themselves from sudden, large price changes. Others – known as speculators – don’t have any interest in taking delivery of the underlying commodity but only want to take advantage of price gyrations for potential profit.
Futures are regulated by the Commodity Futures Trading Commission, which oversees how futures markets function including setting limits on price fluctuations and supervising how brokers handle investor money. They also serve as a kind of backstop to all trades, guaranteeing that a futures contract will be honored on its expiration date and reducing so-called counterparty risk. Since actual delivery of the underlying commodity is rare, a futures contract generally expires on a quarterly or monthly basis. When a contract does expire, it’s liquidated. If a buyer believes that the price of the underlying will rise, they go long; if they believe the price of the underlying will fall, they short a futures contract.