Monday, December 30, 2013

What is a Future Contract

A future contracts obligate the seller to deliver a commodity or other financial instrument to the buyer at an agreed upon date in the future.

Every contract must have a buyer and a seller and they must be standardized in order to facilitate trading on a futures exchange. Traders publically set a price for subsequent delivery within a specified time period and place. Exchange specifies major terms and conditions of the contract, except for the price. The buyer and seller of the contract make equal and offsetting commitments.  These commitments are legally binding, but can be offset.  Most futures contracts do not result in delivery and some do not permit delivery. For ICM Brokers, delivery is not permitted.

Futures contracts were traditionally used to trade commodities like sugar and coffee. It’s an obvious fact that futures market has become an important economic tool to determine prices based on today's and tomorrows estimated amount of supply and demand. Futures market prices depend on a continuous flow of information from around the world and thus require a high amount of transparency. Factors such as weather, war, debt default, refugee displacement, land reclamation and deforestation can all have a major effect on supply and demand and, as a result, the present and future price of a commodity. This kind of information and the way people absorb it constantly changes the price of a commodity. This process is known as price discovery. Futures markets are also a place for people to reduce risk when making purchases. Risks are reduced because the price is pre-set, therefore letting participants know how much they will need to buy or sell. 
This helps reduce the ultimate cost to the retail buyer because with less risk there is less of a chance that manufacturers will jack up prices to make up for profit losses in the cash market. 

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