In economic terms, a future is a contract during a specific period of time for stocks, loans, deposits, indexes or other financial instruments which have their faces values previously established along with its purpose and its expiration of maturity date. These are bought, sold and negotiated within a structured marketplace. Futures are typically considered to be part of the category of financial instruments called derivative contracts.
A future is a contract that lasts a specific amount of time between different parties in which these parties agree to buy or sell a set number of determined goods (which are denominated underlying assets) at an established date and price. To describe this term in another way, in reality a future is a bet between the different parties (a buyer and seller of the future) in which one party considers the price of an underlying asset is going to increase while the other party believes it’s going to decrease so they make a contract along these lines. This explanation is only applicable if the nature of the contract for the future is speculative, even though these contracts have many other uses.
Future contacts can exist due to:
- If a person is trying to carry out a hedging operation: a person or entity has or is going to have an underlying asset (which could be in the form of petrol, gas, a loan, shares of a companies, etc.) in the future for which they make a future contract which will ensure the price of the assets (by which one can the price of something unsure more definite in the future by increasing the level of certainty of the operation). Also, this might be the case if the good will be needed in the future and it’s desirable to make a contract that will already have established its price at that point in time.
- If a person is trying to carry out a speculative operation: a person or entity that contracts a future who is looking to generate a profit from this operation through the evolution of the price underlying asset from the signing of the contract until its maturity.
- Arbitrage: obtaining a profit without running any risk. When making a transaction with a future contract, the definition and specification of the buyer (assuming the long position) and the seller (assuming the short position) must be established.
- The buyer of a future (the long position) has the right to receive the matured contract which would be the underlying assets which was negotiated in the contract.
- The seller of a future (the short position) has the obligation to hand over the underlying asset that was negotiated in the contract and, therefore, receives the amount of money that was agreed upon in the contract.
The main characteristics of a future contracts are:
- These are regulated and standardised contracts (in contrast to other derivatives that can be negotiated and modified by the interested parties) for all participants in the market in terms of the reference to underlying assets, the purpose of the contract, the maturity date and the payment.
- They are negotiated through a clearing house, with standardised guarantees and daily liquidations of the positions that were contracted by the different parties.
- There are mechanisms that exist which make it possible to buyout the positions of the contracting parties on a daily basis (which are offered at continual rates).