A futures contract is a legally binding agreement, or an obligation, to buy or sell a commodity or financial instrument at a specific price, and at a specific time in the future. Futures contracts are standardized according to the quality, quantity and delivery time and location for each commodity. Unless you offset your original position beforehand, you must buy or sell at the agreed-upon price when the contract expires.

There are two types of futures contracts – those that provide for physical delivery of a particular commodity, and those that call for an eventual cash settlement. The commodity itself is specifically defined, as is the month when delivery or settlement is to occur. A July futures contract, for example, provides for delivery or settlement in July.

In the case of delivery-type futures contacts, very few actually result in delivery. Not many speculators, or even hedgers, have the desire to take or make delivery of, say, 5,000 bushels of grain or 50,000 pounds of pork. Rather, the vast majority of those utilizing futures contracts choose to realize their gains or losses by buying or selling an offsetting futures contract prior to the delivery date.

Cash-settled futures contracts are those which are settled in cash rather than by delivery at the time the contract expires. Stock index futures contracts, for example, are settled in cash on the basis of the index number at the close on a specified day. Delivery of the actual shares of stock that comprise the index would obviously be impractical.

Selling a contract that was previously purchased liquidates a futures position in exactly the same way, for example, that selling 100 shares of stock liquidates an earlier purchase of 100 shares of the same stock. Similarly, a futures contract that was initially sold can be liquidated by an offsetting purchase. In either case, gain or loss is the difference between the buying price and the selling price, less transaction costs.