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What Are future contract.

Future contract !!!!!!!!!!!!!!!!!!

What are future contract Derivative.


Futures markets were innovated to overcome the limitations of forwards. A futures  contract is an agreement made through an organized exchange to buy or sell a fixed  amount of a commodity or a financial asset on a future date at an agreed price. Simply,  futures  are  standardised  forward  contracts  that  are  traded  on  an  exchange.  The  clearinghouse associated with the exchange guarantees settlement of these trades. A  trader, who buys futures contract, takes a long position and the one, who sells futures,  takes a short position. The words buy and sell are figurative only because no money or  underlying asset changes hand, between buyer and seller, when the deal is signed


future contract, derivative future contract.
Future Contract.



It is important to understand what actually futures prices indicate?

 If we say  May 2020 index futures contract is trading today (in March 2020) at 10200, what does it  mean. We can explain this by saying that that market expects the cash index to settle at  10200 at the closure of the market on last Thursday of May (i.e., on the last trading day  of the contract which is May 31, 2020). Point is that every participant in the market is  trying to predict the cash index level at a single point in time i.e. at the closure of the  market on last trading day of the contract, which is Thursday in our example. 

This results  in price discovery of cash index at a specific point in time. Now, we may also state that  futures prices are essentially expected spot price of the underlying asset, at the maturity  of the futures contract. Accordingly, both futures and spot prices converge at the  maturity of futures contract, as at that point in time there cannot be any difference  between these two prices. This is the reason why all futures contracts on expiry settle at  the underlying cash market price. This principal remains same for all the underlying  assets.


Features of futures contract 


In futures market, exchange decides all the contract terms of the contract other than  price. Accordingly, futures contracts have following features

 Contract between two parties through Exchange 
 Centralised trading platform i.e. exchange   
 Price discovery through free interaction of buyers and sellers 
 Margins are payable by both the parties 
 Quality decided today (standardized )  
 Quantity decided today (standardized)  


Pricing of a futures contract depends on the characteristics of underlying asset. There is  no single way to price futures contracts because different assets have different demand  and supply patterns, different characteristics and cash flow patterns. This makes it  difficult to design a single methodology for calculation of pricing of futures contracts.  Market participants use different models for pricing futures. Here, our discussion is  limited to only two popular models of futures pricing ‐ Cash and Carry model and  Expectancy model.  


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The analogy I have used might not be 100% correct but it’s easy to understand things with a simpler analogy.

 That’s it for this post. Do check out my other posts to gain more knowledge about finance.



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Location: Solapur, Maharashtra, India

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