Futures contract

Quick definition

By:

Max Adams

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Charlie Hancox

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Updated: Jan 20, 2023

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Futures contracts are agreements between two parties to make a trade on a specified date in the future, with the price agreed in advance.

Key details

• These contracts are legally-binding and used to lock in the future price at which you can buy or sell an asset.
• Futures contracts are useful when trading a variety of assets, such as stocks, indices, forex, commodities, and cryptocurrencies. 
• They provide certainty and reduce risk by guaranteeing a set price regardless of how the market moves in the meantime.

What are futures contracts?

It’s helpful to think of a futures contract as a prior agreement to make a trade. If you ask a friend to buy you a ticket to an event and say you’ll pay them in exchange for the ticket when you see them next week, that’s a basic form of futures contract.

This is often how things work in commodities trading: farmers cannot predict with 100% certainty how their harvest will go, so they sell futures contracts for the amount they expect to produce. Whatever happens, the farmer is guaranteed the money they receive for the contract, regardless of the success of the harvest.

You can use futures contracts to try to predict how the market will move. For instance, if you believe that the price of oil will rise over the next month, you can take out a futures contract that entitles you to buy it in a month at the present-day price. If the price does indeed rise, then you’ve made a successful trade, but if it doesn’t then you are forced to pay above market rate.

What are the benefits of using a futures contract?

Originally, the main benefit of a futures contract was to guarantee agricultural producers some income and protect them from unforeseen disasters. Nowadays, that benefit still exists but has been joined by some which are more specific to the way futures are traded today. Here is a quick summary of the key benefits:

• Mitigating risk. As a futures contract guarantees the price at which you buy or sell an asset ahead of time, they eliminate the risk of dealing with expected expenses and profits
• Reduced trading fees. Futures contracts are generally cheaper to trade than buying assets like stocks and cryptocurrencies. 
• Longer trading hours. Many futures markets allow trading to take place beyond traditional market hours, giving you greater control over your investments. 
• Ability to use more leverage. Many broker platforms allow you to use much more leverage when trading futures as compared to simply buying or selling an asset outright.

Where can I learn more?

To learn more about futures contracts, and about investing in general, head over to our courses. There you can find helpful guides to every different trading method and learn how to analyse and predict market movements.