In modern financial terminology, a futures contract is basically a standard legal agreement to purchase or sell something in the future at a predetermined price in a specified period of time, between parties not necessarily acquainted with each other. The object transacted is normally a specific financial instrument or commodity. For example, you might enter into a futures contract to purchase oil on a particular date in the near future. The specific date could be anywhere from six months to a year from now.
The spot price of oil will be determined by various economic factors such as current oil prices, general world conditions, and other external factors
The buyer of the oil futures contract will pay for the contract based on the spot price at the given date. If the buyer of the oil futures contract decides to sell before the contract expires, he will be charged a fee called a premium.
Futures contracts are often used as financial tools, since they enable traders to profit from a security even if the market changes quickly and prices fluctuate unpredictably. Futures contracts, however, also allow speculators to make money on stock indexes. An index, such as the Dow Jones Industrial Average, is a standardized benchmark that represents the price performance of a particular company over a specified period of time Futures Contract. Speculators use futures contracts to speculate on the direction of an index . If an investor believes that a stock is likely to rise, he will usually buy a futures contract that will allow him to profit if the stock rises. In the same way, should the investor believe that a stock will fall, he will sell a futures contract that will allow him to incur losses if the stock falls.
Futures contracts are generally traded over short periods of time. During the trading day, market participants either buy or sell options contracts and therefore control trading liquidity. Investors in futures trading do not pay taxes or dividends to the government, as with most stock transactions. Because trading is done over short periods of time, it has the potential to be very profitable for all traders involved. The lack of paperwork and strict compliance procedures means that trading on futures does not require the same accounting standards as other types of trading, making it ideal for small investors.
Futures contracts are leveraged, meaning that a trader is required to either provide upfront cash, put up collateral, or use some type of margin. As a result, when a trader wants to trade Futures contract, he must put up additional collateral. Usually, this type of funding is provided by a business or another qualified investor. If a trader does not have enough collateral to cover the full amount of the contract, he may offer to pay the difference from other funds.
Since a Futures contract allows the buyer a direct, and almost instantaneous access to the asset being traded, a margin account is required. A margin account is typically a type of savings account, with a few exceptions. If a trader does not use a bank, he may open his own account at a brokerage firm, which will require a minimal amount of capital to hold the balance.
Futures contracts allow the buyer an asset in a defined quantity at a fixed price on or before a defined expiration date. The asset can be in the form of stocks, indices, commodities, bonds, or any other financial or non-financial product that has potential for growth. The contract defines the value of the asset at the expiration date, and the seller pays a premium to the buyer for the right to purchase the asset. When the strike price is reached, the seller must sell the assets or exercise the options contracts.
Futures contracts can be traded via electronic messaging systems (e-mail and Web sites), telephone, or Internet. An online futures broker provides access to the exchange markets, where trading occurs on a 24 hour basis. An online futures broker is the best choice for a new investor who is unfamiliar with the futures markets. A futures broker takes the guesswork out of investment decisions by providing comprehensive information about the underlying assets and the current market. They also offer advice for risk management and help develop investment strategies.