I would suggest you to read the previous article before reading this.
What is meant by Futures Contract?
Consider this, You are using some Direct To Home (DTH) service. There are many DTH service providers. Say you have chosen X. Now you and company X get into a contract stating that you will be using their service from today to say an year exactly. You agree with the company as to how many channels you want and how and when you will make a payment. All this being done today for next one year. If there are variations in the price in the next one year, your contract with company X is honored and they can’t change it at a later date. In this way you are hedging the risk of price increase. The company makes a profit some how or the other, we will not think about it.
Similarly, think that there is a farmer who sells sugarcane to a sugar factory. Now the farmer says he will produce 1000 kgs of sugarcane and give it to buyer at Rs.10 per kg after 6 months. The buyer agrees for the contract. This is Futures contract. Buyer is not sure about the price and seller is also not sure, both are speculating the price. They come to final conclusion about the price assuming it is fair for both the parties. If the price of sugarcane increases after 6 months then buyer makes a profit if it falls then the seller makes a profit. So, a futures contract is an agreement between two parties: a short position – the party who agrees to deliver a commodity – and a long position – the party who agrees to receive a commodity. In the above scenario, the farmer would be the holder of the short position (agreeing to sell) while the buyer would be the holder of the long (agreeing to buy).
In every futures contract, everything is specified: the quantity and quality of the commodity, the specific price per unit, and the date and method of delivery. The “price” of a futures contract is represented by the agreed-upon price of the underlying commodity or financial instrument that will be delivered in the future.