Future

A future is the most basic derivative. In SDX Commodities & Energy it can be priced in either of the pricing pages.

It is a contract in which two parties agree to complete a predefined transaction at a predetermined time in the future using the future price. Because the two parties have the obligation (and not the right) to carry out the transaction, a forward contract has no premium.

On the expiry date, it is the difference between the current underlying and the future price that changes hands.

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 underlying by locking yourself into the future price.

The buyer enters into the contract to protect itself from a future increase in interest rates and wants to fix its borrowing costs today. The seller wants to protect itself from a future decline in interest rates. This strategy is used by investors who want to hedge the return obtained on a future deposit.

The forward rate is the agreed upon price of an asset in a forward contract. For example, in the FX market it is the rate at which two counterparties agree to exchange currencies at a future date. In the commodities market it defines the market price per unit of the commodity on the delivery date.

The forward rate, set on the forward contract's trade date, is calculated by adding the forward points to (or subtracting them from) the underlying. The forward points take into account the cost of carry on the position, that is, where relevant, lost interest/dividend opportunities, convenience yield, and storage costs, etc.