Future Instrument

Definition

Future Instrument. Agreement to buy or sell a specific amount of a commodity, a currency or a financial instrument at a particular price on a stipulated future date.

A futures contract obligates the buyer to purchase the underlying commodity, currency or financial instrument and the seller to sell it unless the contract is sold to another before settlement date which may happen if a trader waits to take a profit or cut a loss.

Notes

This contrasts with options trading in which the option buyer may choose whether or not to exercise the option by the exercise date. Unlike options, futures convey an obligation to buy.

Futures contracts are forward contracts, meaning they represent a pledge to make a certain transaction at a future date. The exchange of assets occurs on the date specified in the contract.

Futures are distinguished from generic forward contracts in that they contain standardized terms, trade on a formal exchange, are regulated by overseeing agencies, and are guaranteed by clearinghouses. Also, in order to insure that payment will occur, futures have a margin requirement that must be settled daily. Finally, by making an offsetting trade, taking delivery of goods, or arranging for an exchange of goods, futures contracts can be closed. Hedgers often trade futures for the purpose of keeping price risk in check.

Risk Profile

The Risk to the holder is unlimited, and because the payoff pattern is symmetrical, the risk to the seller is unlimited as well. Dollars lost and gained by each party on a futures contract are equal and opposite. In other words, futures trading is a zero-sum game.

References

• Barrons, adapted by EDMC SMER.

Disclaimer

This entry annotates a FIBO Ontology Class. FIBO is a trademark and the FIBO Ontology is copyright of the EDM Council, released under the MIT Open Source License. There is no guarantee that the content of this page will remain aligned with, or correctly interprets, the concepts covered by the FIBO ontology.