In trading, a “contract” typically refers to a standardized agreement between two parties to buy or sell a specific asset at a predetermined price and time.
The term is most often associated with futures, options, and Contract for Differences (CFD) markets, although it can also refer to other types of financial agreements.
Let’s take a closer look at the context of futures, options, and CFDs:
What is a Futures Contract?
This is a legal agreement to buy or sell a particular commodity or financial instrument at a predetermined price at a specified time in the future.
The buyer of the futures contract is taking on the obligation to buy and receive the underlying asset when the futures contract expires. Conversely, the seller is agreeing to deliver the asset at the expiration date.
What is an Options Contract?
This is a type of derivatives contract that gives the buyer of the contract the right, but not the obligation, to buy or sell an underlying asset at a specified price within a specific time period.
The seller (or writer) of the option, on the other hand, is obligated to sell or buy the asset if the buyer chooses to exercise the option.
What is a Contract for Difference (CFD)?
A CFD is a financial derivative that allows traders to speculate on the rising or falling prices of fast-moving global financial markets, such as forex, indices, commodities, shares, and treasuries.
In a CFD, the buyer pays the seller the difference between the current value of an asset and its value at contract time if the difference is positive, and vice versa if the difference is negative.
The key point about CFDs is that you never actually own the underlying asset, but you’re merely speculating on price changes.
Each contract has terms that specify the quantity of the asset to be delivered or purchased, the price at which the asset will be bought or sold, the date of the transaction, and the method of delivery (in the case of futures).
Futures and futures contracts are often traded on exchanges, which standardizes the terms of the contracts to facilitate trading.
Trading in contracts allows traders to speculate on the price movement of the underlying asset, and it can also provide a method for hedging against price changes