Underlying Futures Contract

What is an Underlying Futures Contract?

The term Underlying Futures Contract is commonly used in trading, precisely in the futures market. To put it plainly, an Underlying Futures Contract denotes a legal agreement to buy or sell a particular asset or commodity at a predetermined price at a specified time in the future. This asset or commodity, which can be anything from oil to currency, is the 'underlying' asset of the contract.

Essence of Underlying Futures Contract

The concept of an Underlying Futures Contract comes into play because traders are not buying or selling the physical asset when trading futures. Instead, they are trading the contract that is associated with that asset. So when we say traders are buying oil futures, for instance, what they are really buying is the contract and the promise it holds.

Significance in Trading

Understanding the Underlying Futures Contract is critical for traders who participate in the futures market. The value of the contract depends entirely on the price of the underlying asset. Consequently, traders must closely observe the asset's performance as fluctuations can affect the contract's value. By doing so, they can anticipate market trends and potentially make substantial profits from their trades.

Example of Underlying Futures Contract

Let's take gold as an example. Assume a trader believes that the price of gold will rise in three months. To leverage this belief, they can purchase a gold futures contract. Here, gold is the underlying asset of the futures contract. If the price of gold does increase, as expected, the trader will make a profit by selling the futures contract at a higher price.

Underlying Futures Contract: The Takeaway

The Underlying Futures Contract is a fundamental concept in the world of trading, particularly for those dealing in futures. Understanding this concept allows traders to leverage market trends better and informs their trading strategy, ultimately driving their trading success.