A futures contract (f) is a contract in which two parties (the buyer and the seller) agree to complete a predefined transaction at a predetermined time in the future using the future price (the initial contract price).
The contract commits both counterparties to the trade, unlike an option which does not impose any obligations on the holder. Because the two parties have the obligation (and not the right) to carry out the transaction, a forward contract has no premium.
Traded on a futures exchange, these contracts ensure their liquidity by being highly standardized, usually by specifying the following—type, amount and units of the underlying asset per contract; currency in which the futures contract is quoted; delivery month; last trading date; type of settlement (cash settlement or physical settlement), and the grade of the deliverable and the manner and location of delivery in case of physical settlement (e.g., the NYMEX Light Sweet Crude Oil contract specifies the acceptable sulfur content and API specific gravity, as well as the location where delivery must be made).
If a future is physically settled, on the settlement date the delivery is made and paid for. Otherwise the future is settled periodically, usually daily. The exchange necessitates both parties to maintain a minimum amount in a margin account, which at the end of each trading day is adjusted to reflect each party’s respective gain or loss based on the new futures price, i.e., at the end of each day the account is marked to market. For this reason there is no discounting of expected future value of the futures payoff and hence interest rates do not need to be taken into account.
Why use a future?
A future is used to control and hedge risk. You remove the risk of being exposed to future fluctuations in the asset's price by locking yourself into the future price.
A buyer enters into the contract to gain protection from a future increase in the asset price, for example, by being able to fix the costs of future purchases today. A seller enters into the contract to gain protection from a future decline in the asset price.
Pricing a future in SDX Commodities & Energy
When pricing a future in SDX Commodities & Energy you need to define its underlying futures contract in the Future Term field in the Single Option page or the Expiry/Term field in the Portfolio page. You can only enter an existing futures contract.
For a list of these contracts for each asset see the Future Contract column in the asset's Term Structure page, which can be accessed as follows:
On the ribbon bar from the Trader, Structurer and Market Data tabs.
From the System Menu which is opened by clicking the Open button on the ribbon bar.
From the left hand side of the pricing page.