What does it exactly mean by saying "buy/sell a futures contract"?

Question

If I buy a crude oil futures contract at $20/barrel and sell it later at $10/barrel, I seem to buy/sell two different contracts. First, the entities of the contract change from me and exchange to another guy and exchange. Second, is the commodity price indicated by the contract changed also, i.e., from $20 to $10? Does the guy who buys the contract from me still need to pay $20/barrel if he holds it till the delivery date to receive the real crude oil? What is the exact content included in a futures contract? What is exactly I'm buying/selling?

Answer 1

What's happening is something called novation. When you trade futures, you agree to open a contract with the other party. In your case you 'buy' and the other party 'sells', but you never know who this party is, and you never have a contractual relationship with them. This is because the exchange inserts itself into the contract on both sides. So, every participant is actually conducting business with the exchange only. The exchange is taking no risk with respect to the price, because all of these contracts are symmetric.

Of course the exchange takes on counterparty risk, but this is mitigated through the use of margin and clearer relationships.

This setup means that you can 'open' the contract vs another trader, and 'close' it with another, because in all cases you are actually conducting business with the exchange, under the terms of your contract with the exchange.

Answer 2

One of the legal entities on a futures contract is fixed - the writer of the contract. This is the entity who originated the contract and is usually a producer for commodities contracts or a bank or broker for financial futures. The other entity is essentially "bearer" meaning that the holder at expiry is the one who fulfils the other party to the contract. This is exactly the same as other exchange traded contracts. Note that the exchange is not a party to the contract they just facilitate the trading and set some basic rules on the text of the contract.

The contract fixes the quantity, delivery date (expiry), price and the contract writer but keeps the deliveree as bearer so that it can be traded. For a contract that stipulates delivery of the underlying the contract itself is the right to ownership of the quantity of the underlying at the price stated on the expiry date from the contract writer. Many contracts these days are financially settled so the difference between the contract price and the spot price of the underlying is delivered as cash at expiry instead of delivering the underlying.