Futures: what is a future?
A future is a contract for the future delivery of commodities, shares, securities, foreign currency or other financial instruments. Futures are a variety of forward contract. At its simplest that is an agreement to buy or sell a fixed amount of a commodity or financial instrument at a specified future date and at a pre-agreed price. They give the holder not just the right but the obligation to buy or sell at the specified price.
Futures come in two forms:
- Exchange-traded futures
Exchange-traded futures are forward contracts made in the standard form required by a futures market or exchange. The contract is in a standard form as it is the futures themselves that are traded. The function of the futures exchange is to provide a market in which the contracts can be bought and sold.
It would be unusual for an exchange-traded future to be completed by delivery of the underlying commodity or financial instrument. The contract will usually be closed out by buying another future with reciprocal obligations.
- Over-the-counter futures
Over-the-counter (‘OTC’) futures are forward contracts, usually created by financial institutions, designed to meet the specific needs of particular people.
There is no established market in over-the-counter futures. They will often run to maturity unless they can be settled by making a monetary payment.
Though over-the-counter forward contracts may be referred to as futures, commercially that term is more commonly confined to exchange-traded contracts. The TCGA refers to both forms of contract as a future.