A Futures Contract Is Nothing but a Forward Contract That Is

A futures contract is nothing but a forward contract that is standardized, tradable and regulated. This means that parties can enter into a futures contract with the confidence that the terms of the contract are clear and enforceable. In contrast, a forward contract is an agreement between two parties to buy or sell an asset at a predetermined time in the future, but it is typically not tradable in a secondary market.

The main benefit of a futures contract is that it provides a way for participants in a market to hedge against price fluctuations. For example, a farmer might enter into a futures contract to sell their corn crop at a fixed price before the crop is even harvested. This allows them to lock in a price and protect against the risk of falling prices. Similarly, a commercial airline might enter into a futures contract to purchase jet fuel at a fixed price in order to hedge against the risk of rising fuel prices.

Another benefit of futures contracts is that they provide liquidity to markets. By providing a standardized contract that can be traded on an exchange, futures contracts make it easier for buyers and sellers to find each other and negotiate a price. This creates a more efficient market and can lead to lower transaction costs for participants.

Futures contracts are typically settled in cash rather than physical delivery of the underlying asset. This means that participants do not need to worry about the logistics of delivering or receiving the asset, which can be particularly important for commodities like oil or wheat where physical delivery can be difficult and expensive.

It is important to note that futures contracts are not without risk. Participants need to carefully consider their ability to meet margin requirements and the potential for losses if the price of the underlying asset moves against them. However, for those who are able to manage these risks, futures contracts can be a powerful tool for managing price risk and participating in markets.