A “future” is a tradable contract that commits you to taking delivery (if you buy), or making delivery (if you sell), of an agreed amount of something at an agreed time. Futures contracts are typically used for trading commodities (such as oil, gold, corn or even lean hogs) or foreign currencies.
For example, you might buy a contract to take delivery of ten tons of iron at £10,000 on a date in February. If you pay a 10% deposit on the iron (£1,000) to secure the contract and if the price per ton had risen to £1,400 by the time you took delivery in February, you would make a £4,000 profit on the iron by selling it for £14,000. If prices fall you’ll lose money.
In reality, most traders never see the end product, as they will buy or sell a contract of identical size to close out their positions before the delivery date – instead, futures offer a way to make bets with borrowed money on the direction of various prices. An “option” is similar to a future, but it gives the buyer the right, not the obligation, to buy (or sell) a certain asset at a specific price during the time of the contract. Both futures and options are types of “derivatives”.
• Watch Tim Bennett’s video tutorial: What are futures?