Definition
Futures are standardized financial contracts obligating the buyer to purchase, or the seller to sell, a particular asset (such as commodities, currencies, or indices) at a predetermined price and date in the future. Futures contracts are traded on exchanges and are commonly used by investors and companies for hedging or speculation. These contracts can be settled physically (by delivering the asset) or financially (by cash settlement). Futures are used to manage price risk on assets that have volatile prices and can also be used to speculate on future price movements.
Key Features of Futures Contracts:
- Standardization: Futures contracts are standardized in terms of quantity, quality, and delivery terms, making them easily tradable on exchanges.
- Leverage: Futures typically require a margin deposit, allowing traders to control a large position with a smaller initial investment.
- Hedging and Speculation: Used by producers and consumers to hedge against price fluctuations, and by traders to speculate on price movements.
- Expiration and Settlement: Futures contracts have a set expiration date, at which point the contract is settled either through delivery or cash settlement.
Case Study
An example can be seen with crude oil futures on the Multi Commodity Exchange (MCX). Suppose an investor expects crude oil prices, currently at ₹6,500 per barrel, to rise over the next month. The investor buys one crude oil futures contract, which represents 100 barrels, locking in the price at ₹6,500. If, after a month, the price rises to ₹6,800 per barrel, the investor earns ₹30,000 (₹300 × 100) as profit. However, if the price falls to ₹6,300, the investor incurs a loss of ₹20,000. Futures contracts in India are widely used by traders, investors, and companies to hedge against price fluctuations or to speculate on future price movements in commodities, indices, and stocks.
Historical Reference
The first recorded organized futures market in the world was established in 1730 in Osaka, Japan, at the Dōjima Rice Exchange. Merchants and samurai traded rice coupons that represented future delivery of rice — effectively functioning as early futures contracts. These contracts helped stabilize rice prices and provided a mechanism for managing supply and demand, making Dōjima the birthplace of formal futures trading.
In the modern financial sense, standardized futures contracts as we know them today began in 1848 with the creation of the Chicago Board of Trade (CBOT) in the United States. CBOT introduced standardized agreements for commodities like corn and wheat, setting fixed contract sizes, delivery dates, and quality grades. This marked the beginning of the regulated futures market that later expanded to include financial instruments such as currencies, interest rates, and stock indices.