Futures
Futures are standardized forward contracts that are traded on public exchanges (e.g. CME, CBOT, ICE) rather that OTC. Standardization requirements of futures include:
- Specifying the notional value per individual contract (e.g. 5,000 bushels of corn, or $100,000 face amount of 30-year treasury bonds).
- A cash collateral, known as margin, adjusted daily to account for changes in futures prices, known as marking to market. It is done to
- Delivery month and location(s).
- Quality requirements for commodities.
Since futures prices converge in maturity towards the spot price of the underlier per Covered Interest Parity, the difference between the spot price and the futures price is known as the futures basis. Investors may bet on the convergence or divergence of the futures and spot prices in a basis trade.
If an investor does not require the actual commodities associated with a future contract, they may close it out with an offsetting trade. However, there are tales of investors forgetting to close out contracts and being forced to take/receive cattle and corn.