Trading futures ensures buyers and sellers they will be able to trade a contract for a pre-determined price at a pre-set date. Since the prices in securities that determine the value in a futures contract are often volatile, the ability to lock in a price becomes attractive to some businesses.

Identification

Futures contracts receive their value and trade based on an underlying commodity or financial instrument such as currency. These may include agricultural commodities such as soybeans or wheat or energy resources including crude oil and natural gas. These contracts are traded on a futures exchange.

Benefits

The primary benefit of a futures contract is that both parties in a transaction are guaranteed a price. For instance, a transportation company that depends on fuel for business, such as an airline, can purchase a futures contract on oil and gas to protect against rising energy costs in the future.

Features

Farmers are often the sellers of futures contracts. They do this to lock in a price for a crop. Commodity prices can be volatile and, by securing a price for a crop, a farmer is hedging his position so that in the event prices turn lower, he is guaranteed a payment at the rate determined at the start of the contract.

Considerations

Buyers and sellers in a futures contract can lose potential profits. For instance, if the market value of a commodity rises above the futures price, a seller is obligated to sell the contract at the agreed-upon price. In this instance, a seller might attempt to settle the contract for cash to mitigate losses rather than deliver the physical asset at the end of the contract. This is known as cash settlement.

Profits

Investing in the futures markets can be a highly profitable endeavor for investors. In 2009, as the global economy was rising out of an economic recession, oil prices soared 77 percent, according to BusinessWeek. This increase prompted investors to pocket returns and settle contracts in the last week of December.

Source:

BusinessWeek: Crude Oil Snaps Five Days of Gains as Investors Lock in Profits

More Information:

CME Group: The Basics Resource Center