A financial future is a standard contract between a buyer and a seller in which a buyer has a binding obligation to buy a fixed amount (i.e. the contract size) at a fixed price (the future price), on a fixed date (delivery date or the expiration date) of some underlying assets. E.g. if we bought sterling pound futures than we will have a binding obligation to buy a fixed amount of sterling pound at a fixed rate at a fixed date. Similarly a seller would have a binding obligation to deliver a sterling pound. This is similar to a forward exchange contract to buy sterling pound from a bank.
However, certain important differences exist. These are:
- Each currency future is traded in units of a fixed size such that fractions of contracts cannot be bought or sold.
- Whereas forward exchange contract with banks can be drawn up for any date in future, delivery date for currency futures occur only on 4 dates per year, (March, June, September and December). This may appear to be a severe restriction but in practice most future contracts are sold before they reach maturity.
- A financial future exchange offers a physical meeting place for buyers and sellers. Dealing on floor between member firms is by open outcry.
- Transaction costs on future exchange are paid as a percentage commission.
- Buyers and sellers are required to deposit margins to ensure credit worthiness. Profit or losses on contracts are also received and paid throughout the life of the future.