About Futures
A futures contract is a legally binding agreement to buy or sell a specific quantity and quality of a particular commodity or financial instrument at a pre-determined time in the future, at a price agreed upon today.
To enable trading and clearing, futures contracts are standardised in all aspects except price and the identity of buyers and sellers. These are determined when the contract is made.
Futures can be an important hedging mechanism for anyone actively involved in any trading in global markets, or anyone for whom currency movements, interest rate movements or sharemarket movements could mean a significant alteration to their profits. Futures contracts offer investors a highly leveraged investment at relatively low cost.
Expiration of a futures contract
All futures contracts are quoted with a settlement month (also known as a contract month). The exact day in that month when the future expires is known as the maturity date or the last trading date.
Closing out
Positions under a futures contract, once established, can either remain open until the maturity date, at which time delivery is effected or the contract is cash settled, or be closed out prior to expiry. This is done by offsetting - buying or selling an equal and opposite position in the same delivery month at any time prior to expiry.
For example, a seller of a futures contract can buy an equal and opposite futures contract at any time, thus offsetting one contract with another and closing out the position. By offsetting a futures contract, the seller cancels any obligation they had made by entering into the original futures contract. The difference between the price of the futures contract when the trade was initiated and the price when it is offset, is the net profit or loss made.
Approximately 97% of all futures contracts entered into are closed out prior to expiry. This process assists in the development of liquidity, as there are usually two-way prices in the futures market (a buying and a selling quote) which allow traders to enter and exit the market at will.
To close out, the buyer sells futures and the seller buys futures.
