A future is an agreement between two parties to buy or sell an asset at a specified quantity for a predetermined price on a certain date in the future.
A futures contract is a legal agreement to buy or sell a standardized asset on a specific date or during a specific month that is transacted on an exchange.
An exchange-traded futures contract specifies the quality, quantity, physical delivery time and location for the given product. This product can be an agricultural commodity, such as 5,000 bushels of soybeans to be delivered in the month of May, or it can be a financial asset, such as the U.S. dollar value of British Pounds in the month of December.
The specifications of the contract are identical for all participants. This characteristic of futures contracts allows the buyer or seller to easily transfer contract ownership to another party by way of a trade. Given the standardization of the contract specifications, the only contract variable is price. Price is discovered by bidding and offering, also known as quoting, until a match, or trade, occurs.
Futures contracts are products created by regulated exchanges. Therefore, the exchange is responsible for standardizing the specifications of each contract.
The exchange also guarantees that the contract will be honored. Every exchange-traded futures contract is centrally cleared. This means that when a futures contract is bought or sold, the exchange becomes the buyer to every seller and the seller to every buyer.
Key elements:
Every futures contract is standardized with a defined contract size, contract value, tick size and expiration calendar.
Some futures contracts, particularly commodity futures contracts, have a risk of physical delivery, with trades in those contracts required to be closed out (long positions sold, short positions bought) by a certain date to avoid delivery risk.