What does a futures contract include?

Futures contracts are standardized and traded on a futures exchange, such as the Chicago Mercantile Exchange (CME) or the Intercontinental Exchange (ICE). They allow companies to lock in commodity prices, hedge risk and invest in various asset classes.

1. Basic assets

The underlying asset is the first key component of a futures contract. It can be a tangible commodity, such as gold, oil, or wheat, or an intangible asset, such as currency or interest rates.

2. Quantity and quality

Each futures contract specifies the specific quantity and quality of the asset that will be delivered, if applicable. The amount depends on the type of asset. For example, a gold futures contract typically controls 100 ounces of the metal, while a crude oil contract typically controls 1,000 barrels of oil. The specifications of the futures contract will also define the quality of the product. For agricultural products, the contract may describe acceptable grades or varieties.

3. Price

A futures price is an agreed price for buying or selling an asset in the future. This is determined through an open market process, where buyers and sellers influence prices based on their demand and supply. Importantly, the price of a futures contract can fluctuate significantly leading up to the delivery month as traders evaluate factors such as market conditions and speculation.

4. Delivery date

A futures contract specifies a future date for delivery or settlement of an asset. The contract also specifies a delivery month, but the seller can usually choose a specific date within that month within the range specified by the exchange.

5. Place of delivery

For physical commodities, futures contracts specify a delivery location. The location is usually a centralized location with easy access to transportation. For example, the U.S. crude oil (West Texas Intermediate, or WTI) contract will be delivered in Cushing, Oklahoma—a key transportation hub for the U.S. oil industry.

6. Contract size

Each futures contract specifies a standard size that is uniform across all contracts for the same commodity or asset. Contract size is critical because it indicates the amount of the asset controlled by the futures contract. For example, a corn futures contract on the Chicago Board of Trade (CBOT) represents 5,000 bushels.

7. Settlement Terms

Futures contracts also specify settlement terms—either physical delivery of the asset (where the seller delivers the physical commodity to the buyer) or cash settlement (where the difference between the contract price and the market price at the end of the contract is settled). While some contracts, such as agricultural commodities or precious metals, may involve physical delivery, most futures contracts are offset or rolled over before the delivery date, thereby settling in cash.

Taken together, the specific nature of their components allows futures contracts to provide an efficient means of managing risk, arbitraging price differences and expressing a view on future price movements. However, there are also risks, and investors should fully understand them and treat them with caution.