What Are Futures?

Price now, deliver later

A futures contract is an agreement: settle on a price today, then exchange cash for goods on a set date in the future. Spot means trading and delivering on the spot.

Standard contracts on an exchange

Futures trade on an exchange, with standardized size, quality and expiration dates. The clearing house stands between buyer and seller and guarantees every contract will be honored.

Who uses futures?

The farmer fears falling prices and the bakery fears rising ones; once they sign, neither worries about price swings anymore. They're hedger. Another group owns no wheat and takes on price risk to profit from price moves: the speculator.

Key takeaways

• A futures contract is an agreement to buy or sell an underlying on a future date at a price agreed today.
• Spot is "pay and take delivery now"; futures are "set the price now, deliver later".
• Futures trade on exchanges with standardized terms, and a clearing house stands between buyer and seller to guarantee both sides.
• A buyer worried about rising prices and a seller worried about falling prices can both lock in a price with futures. Locking in means giving up the luck on the other side.

Try it yourself

You can do these exercises in this lesson's interactive simulation:

1. Click “Example: rises to $8” and watch the delivery at expiration: what price does the bakery buy the wheat at? How much does it save per bushel?
2. Pause halfway through: the spot price is moving, but did the $6 contract price on the chart change? Drag “Spot price at expiration” to $6: what do the two comparison cards show?
3. Click “Falls to $4.5”: who “lost out” this time? Look at the “Farmer vs spot” card: how much more did the farmer get than without the contract?
4. Look at the comparison bar at the bottom: when are spot and futures each priced, and when are the goods delivered?

Quiz and explanations

1. A bakery signs a 3-month wheat futures contract at $6 per bushel. At expiry the spot price has risen to $8. The bakery…

Answer: Still buys at $6, saving $2 per bushel.The futures contract locked in the price, so it settles at the agreed $6.

2. What's the biggest difference between futures and spot?

Answer: Futures set the price now and deliver later.Spot delivers immediately; futures agree on delivery in the future.

3. A farmer sells 5,000 bushels of wheat futures at $6, and at expiry the spot price has fallen to $4.5. Compared with not signing and just selling at spot, how much more does the farmer receive?

Answer: $7,500.$6 − $4.5 = $1.5 more per bushel, × 5,000 = $7,500. $30,000 is the total paid under the contract, and $22,500 is what selling at spot would have brought.

Terms in this lesson

• clearing house (Clearing House): An institution that stands between buyer and seller and guarantees the contract is honored.
• futures (Futures): Standardized exchange-traded contracts to buy or sell an asset on a future date at a price fixed today.
• hedge (Hedge): An opposite trade that offsets the risk of an existing exposure.
• hedger (Hedger): Someone who has (or will have) the physical goods and takes an opposite futures position to lock in a price, aiming to cut risk rather than profit from price moves.
• speculator (Speculator): A trader with no physical goods who takes on price risk to profit from moves, providing the other side and liquidity for hedgers.
• spot (Spot): A trade delivered and paid for right away (or very soon); its price is the spot price.