A futures contract is an obligation to buy or sell a commodity at some time in the future, at a price agreed upon today.
- The contracts themselves are interchangeable. They are standardized as to terms such as the grade of commodity that is acceptable and when and where it can be delivered.
- The word commodity is defined very broadly to include physical commodities, financial instruments, forex and stock indexes.
- The contracts are traded on an organized and regulated futures exchange so that buyers and sellers can easily find each other.
- The exchange clearinghouse is the counterparty to every trade, which not only reduces credit risk in futures trading but also makes it easy for position holders to exit at any time they wish.
Importantly, a futures contract is an obligation (not a right like an option) and that obligation must be fulfilled. In most cases it’s fulfilled by simply making an offsetting trade that takes you out of your original position (sold if one has bought; bought if one has sold). But strictly speaking, you can choose to carry the position all the way to the delivery date, when it’s fulfilled either by the exchange of the physical commodity or by a cash settlement.