A futures contract is one wherein all the pointers of the forward contract are common, except for the price and can be traded. The price being the only variable is a representative of the anticipated future value of the asset at hand. This is why this type of contract is given the title of being a futures contract.
Another technical term for the futures contract is standardized forward contract. Standardization of the contract facilitates trading, as well as leads to a reduction in the costs of transaction.
In practice a futures contract carries the terms and conditions to both the party to carry forward the transaction to the next date, or dates as mentioned in the contract. The party whose equity account is less than the specified amount pays the difference, which is technically termed as variation margin. Thus, by the end of the trading those involved in the contract step into a fresh forward contract. This will have the same maturity date that was printed in the original contract, but giving a revised forward price. This process is known ‘marking to market’. Herein the clearing house replaces each futures contract that exists presently with a new one.
An example of this transaction would be the buyer X and the seller Y step into a 1,000 ton sugar futures contract at the rate of Rs. 10 per ton. Then taking into assumption that on the next day of this the settlement price of sugar is Rs. 10.20 per ton. Then this price fluctuation would lead to a Rs. 1,000 loss to Y, while X earns a profit of the same amount.
The settlement price is considered as the representative price. This particular price is the rate at which the contracts trade in the closing time of the trading time span.
To sum up, the futures contract can also be considered as a roll over forward contract. As pre technical definition of the futures contract it is: A standardized agreement between the buyer and the seller, wherein the seller is obligated to deliver a precise asset to the buyer on the precise date (as stated in the contract); and the buyer is obligated to pay the seller the prevailing futures price on delivery of the asset.
The futures contract consists of the following pointers:
• The date on which the contract is to be executed
• the asset of which the contract is a derivative
• The asset’s quantity
• The price of the contract price