Introduction To Futures
The Basics of Futures Trading
What are Futures?
Futures contracts are standardized to meet the specific requirements of buyers and sellers for a variety of commodities and financial instruments. Quantity, quality, and delivery locations are pre-established. The only variable is price, which is discovered through an auction-like process on the trading floor of an organized futures exchange.
Example
An individual buys one contract of March Corn at $2.25 per bushel on
January 2nd, initiating a long position. This contract calls for the
delivery of 5,000 bushels of Number 2 Yellow Corn seven days before the
last business day of the delivery month (March) at an
exchange-recognized facility. If the purchaser of the March Corn
contract wishes to exit his position on February 15th, he can do so by
selling one March Corn contract.
Assuming that the contract was sold at $2.45 per bushel, the holder of the March Corn contract would receive $1,000.00 (before broker commissions and fees) for holding the position for six weeks:
Profit or Loss = Sale Price – Purchase Price x # of bushels
($2.45 - $2.25 = $0.20 x 5,000 = $1,000.00)
The person in this example is $1,000.00 richer for the experience, and has no further obligation in the Corn market because the sale of the March Corn futures contract at $2.45 per bushel offset the earlier purchase at $2.25 per bushel.
Notice in the previous example that all of the features of the contract were predetermined by the exchange, except the price:
Quantity: 5,000 bushels for Corn futures
Quality of the Corn: #2 Yellow
Delivery time: 7th to last business day of the contract month
Location: exchange-recognized warehouse or transfer station
Because futures contracts are standardized (with price as the only variable), buyers and sellers are able to exchange one contract for another and actually offset their obligation to deliver or take delivery of the commodity underlying the futures contract. Offset means to take an equal and opposite position in the futures market to one’s initial position.