A futures contract is similar to a forward, except that the deal is made through an organized and regulated exchange rather than being negotiated directly between two parties.
Indeed, we may say futures are exchange traded forward contracts.
A futures contract is an agreement between two parties – a buyer and a seller – to buy or sell something at a future date. The contract trades on a futures exchange and is subject to a daily settlement procedure.
Futures contracts evolved out of forward contracts and possess many of the same characteristics. In essence, they are like liquid forward contracts. Unlike forward contracts, however, futures contracts trade on organized exchanges called futures markets.
For example, the buyer of a futures contract, who has the obligation to buy the good at the later date, can sell the contract in the futures market, which relives him or her of the obligation to purchase the good. Likewise, the seller of the futures contract, who is obligated to sell the good at the later date, can buy the contract back in the futures markets, relieving him or her of the obligation to sell the good.
Futures contracts also differ from forward contracts in that they are subject to a daily settlement procedure. In the daily settlement, investors who incur losses pay them every day to investor who makes profits. We shall learn more about this in the coming chapters.
Futures prices fluctuate from day to day, and contract buyers and sellers attempt to profit from these price changes and to lower the risk of transacting in the underlying goods.
Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor’s gain or loss depending upon the futures closing price. This is called marking-to-market.