The Futures Contract

ON-LINE TRADING LESSON
Trading futures and options involves risk and is not suitable for everyone. 

On-Line Trading Lessons

    Courtesy of the Chicago Mercantile Exchange

Lesson 1 -- The Futures Contract

A futures contract is an agreement to buy or sell a commodity at a date in the future. Everything about a futures contract is standardized except its price. All of the terms under which the commodity, service or financial instrument is to be transferred are established before active trading begins, so neither side is hampered by ambiguity. The price for a futures contract is what’s determined in the trading pit of a futures exchange

Random Length Lumber

Take the Random Length Lumber futures contract which trades at the Chicago Mercantile Exchange (CME) as an example. The contract quantity is already determined (80,000 board feet). So is the quality of the Lumber (grade stamped Construction and Standard, Standard and Better, or #1 or #2 2X4’s of random lengths from 8 feet to 20 feet).

The delivery date of the contract is already decided too. That’s when the contract matures. There are six different Lumber futures contracts traded each year, each with a specified delivery date — February, March, May, July, September and November. So when you buy a March Lumber contract, you know the contract matures in March.

The delivery points for Random Length futures contracts are also known. That means if you make or take delivery of 1 Lumber contract (equivalent to 80,000 board feet of Lumber) when the delivery date arrives, you know exactly to which warehouses you can send your truck. (For many commodities, there’s a cash settlement instead of delivery of the actual commodity.)


Here’s an interesting point to remember. Most people who buy and sell Random Length Lumber futures don’t deliver or pick up a load of lumber when the contract matures. They usually offset the trade and get out of the market before that point. They don’t really want the Lumber. They’ve traded the futures contracts for other reasons such as protection against rising or falling lumber prices or simply earning a profit on the trade.

NEXT: Lesson #2 - The Futures Exchange