Futures: Details on Futures Contracts

Each futures contract has a standard set of specifications. You can see the specification for the corn future on the right.

• Commodity - There are two types of futures contracts, those that can provide for physical delivery of a particular commodity (corn, crude oil, wheat, heating oil, etc.) or item and those which call for a cash settlement (financial instrument or index).
   
• Contract Size - The amount of the underlying commodity which is represented by the contract. For instance, 1 corn futures represents 5,000 bushels, while 1 crude oil futures contract usually represents 1,000 barrels. If the corn was trading at $2 per bushel for example, one corn contract will be worth $10,000 ($2 x 5,000).
   
• Price Fluctuation - Tick size is the  minimum fluctuation that the contract can take, in the case of corn it's .25 cents or $12.50 per contract. To prevent massive volatility many futures contracts are limited in the amount their price can fluctuate in one trading day called daily price limit, if the price reaches the upper or lower limit then the contract will be halted until the next trading day.
   
• Trading or Contract Months - This is the specified months for which the particular futures contract can be traded, this is different for each type of futures.
   
• Expiration Date - the date by which the futures trading month ceases to exist at which all obligations are terminated.
   
• Deliverable Grade - the quality of commodity that is to be delivered. For example many crude contracts specify the amount of sulfur that can be in the oil.
   
• Delivery Location - where the physical commodity is to be delivered.
   
• Settlement Mechanism - the terms of the physical delivery of the underlying item or of the cash payment.

Pricing and Limits
As we mentioned before, contracts in the futures market are a result of competitive price discovery. Prices are quoted as they would be in the cash market: in dollars and cents or per unit (gold ounces, bushels, barrels, index points, percentages and so on).

Prices on futures contracts, however, have a minimum amount that they can move. These minimums are established by the futures exchanges and are known as “ticks.” For example, the minimum sum that a bushel of grain can move upwards or downwards in a day is a quarter of one U.S. cent. For futures investors, it's important to understand how the minimum price movement for each commodity will affect the size of the contract in question. If you had a grain contract for 3,000 bushels, a minimum of $7.50 (0.25 cents x 3,000) could be gained or lost on that particular contract in one day.

Futures prices also have a price change limit that determines the prices between which the contracts can trade on a daily basis. The price change limit is added to and subtracted from the previous day's close, and the results remain the upper and lower price boundary for the day.

Say that the price change limit on silver per ounce is $0.25. Yesterday, the price per ounce closed at $5. Today's upper price boundary for silver would be $5.25 and the lower boundary would be $4.75. If at any moment during the day the price of futures contracts for silver reaches either boundary, the exchange shuts down all trading of silver futures for the day. The next day, the new boundaries are again calculated by adding and subtracting $0.25 to the previous day's close. Each day the silver ounce could increase or decrease by $0.25 until an equilibrium price is found. Because trading shuts down if prices reach their daily limits, there may be occasions when it is NOT possible to liquidate an existing futures position at will.

The exchange can revise this price limit if it feels it's necessary. It's not uncommon for the exchange to abolish daily price limits in the month that the contract expires (delivery or “spot” month). This is because trading is often volatile during this month, as sellers and buyers try to obtain the best price possible before the expiration of the contract.

In order to avoid any unfair advantages, the CTFC and the futures exchanges impose limits on the total amount of contracts or units of a commodity in which any single person can invest. These are known as position limits and they ensure that no one person can control the market price for a particular commodity.

Next -->> How to choose a futures brokers

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