A futures contract is a standardized, legally binding agreement to buy or sell a specific commodity, asset, or security at a predetermined price on a specified date in the future.

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These contracts are traded on regulated exchanges, which standardize the contract terms such as quantity, quality, and delivery date, making them interchangeable and highly liquid.

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Both the buyer and seller are obligated to fulfill the contract at expiration: the buyer must purchase, and the seller must deliver or sell, the underlying asset at the agreed-upon price, regardless of the market price at that time. Futures contracts are widely used for hedging against price risk or for speculative purposes across a range of underlying assets, including commodities, currencies, financial instruments, and stock indices. The exchange acts as an intermediary, reducing counterparty risk by guaranteeing contract settlement.

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Example:

Suppose a U.S. exporter knows they will receive €1,000,000 in December and wants to lock in the exchange rate to avoid the risk of the euro weakening. The current futures contract for 125,000 euros, expiring in December, is priced at $1.20 per euro. The exporter sells eight futures contracts (since 1,000,000 / 125,000 = 8), each committing them to sell euros at this rate in December. At expiration, regardless of the actual spot rate, the exporter will exchange their euros for dollars at the agreed $1.20 per euro, receiving $1,200,000 in total.

This protects the exporter from unfavorable currency movements, and the standardized nature of the contract (fixed size, maturity, and terms) ensures liquidity and ease of trading on the futures exchange.

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