Futures Contract Definition and Legal Meaning

On this page, you'll find the legal definition and meaning of Futures Contract, written in plain English, along with examples of how it is used.

What is Futures Contract?

Agreement to sell or buy a financial instrument or commodity at an explicit price and date in the future. Futures contracts differ from an option contract in that the futures contract carries the obligation to buy or sell opposed to carrying the right without obligation.

History and Meaning of Futures Contract

Futures contracts have been used as a form of risk management since the 19th century, when farmers in the United States began using them to lock in prices for their crops. A futures contract is an agreement between two parties to buy or sell a commodity or financial instrument at a specified price on a future date. This allows both parties to hedge against the risk of price fluctuations in the future.

The futures market has since expanded to include a wide range of commodities, including agricultural products, energy, metals, and financial instruments such as stocks, currencies, and interest rates. Futures contracts are traded on exchanges around the world, and the prices of these contracts are determined by supply and demand factors in the market.

Examples of Futures Contract

  1. A farmer enters into a futures contract with a buyer to sell a specific quantity of wheat at a set price on a future date. This allows the farmer to lock in a price for their crop and protect against price fluctuations.

  2. An investor buys a futures contract for oil at a set price, speculating that the price of oil will increase in the future. If the price of oil does increase, the investor can sell the contract at a higher price and make a profit.

  3. A company enters into a futures contract to purchase a certain amount of foreign currency at a set exchange rate to protect against fluctuations in the currency market.

Legal Terms Similar to Futures Contract

  1. Options Contract - An options contract gives the buyer the right, but not the obligation, to buy or sell an asset at a specific price on a future date.
  2. Forward Contract - A forward contract is similar to a futures contract, but it is privately negotiated between two parties rather than traded on an exchange.
  3. Swap Contract - A swap contract is a financial derivative in which two parties agree to exchange cash flows based on a specific financial instrument or commodity.