Standardisation
Also written Standardised contract · Standardization
The exchange fixing a futures contract's size, quality, delivery place, delivery date and permitted price moves, so strangers can trade the same contract on a public market.
In plain language
A forward contract is a private, custom deal — a buyer and a seller negotiate every term themselves, and no one else needs to know the details. A futures contract works differently, and standardisation is the reason why.
On a futures exchange, every contract on a given commodity has the same quantity, quality, delivery place, delivery date and price-fluctuation limits. A trader does not need to check any of these terms before trading, because the exchange has already fixed them — he only needs to agree on price.
How it works
Chapter 3 lists standardisation as the second of the key differences between futures and forwards: futures are "highly standardized by the exchange in terms of quantity, quality, place of delivery and delivery dates," with these specifications made available to the public, while a forward contract's specifications are customised and are not made public.
A commodity futures contract explicitly states the quantity and quality of the goods to be delivered, the acceptable delivery date and place, the method for closing the contract, and the minimum and maximum permissible daily price moves — all fixed in advance by the exchange. The workbook lists standardisation among the advantages of futures over forwards: it increases clarity about every factor that decides a commodity's price, leaves the price itself to supply and demand, and thereby eases participation, which increases liquidity beyond what a forward market can achieve.
A worked example
MCX's gold futures contract fixes a lot size of 1 kilogram, a minimum purity of 995 fineness, delivery at specified accredited vaults, and a defined expiry cycle — the same for every trader on every contract of that series.
Because of this, a jeweller in Mumbai and a bullion dealer in Ahmedabad who have never spoken to each other can both trade the identical contract, confident that "1 lot of MCX gold futures" means exactly 1 kg of .995 fineness gold, deliverable on the same terms, for both of them. Neither side has to negotiate quantity, quality or delivery location — the only thing they negotiate is price, which is exactly what lets the exchange bring together a large, liquid, anonymous pool of buyers and sellers instead of the one-to-one matching a customised forward contract needs.
Why NISM asks about it
Chapter 3 (Commodity Futures), section 3.2 (Distinction between Forwards and Futures) and section 3.7, which lists standardisation among the advantages of futures over forwards. Expect a distinguishing question pairing standardisation with public availability of contract specifications, against a forward's customised, non-public terms.
Common exam traps
- Standardisation covers quantity, quality, delivery place and delivery date together — a contract standardised on quantity alone is not what the term means here.
- The specifications are made public for futures; a forward's customised terms are not — this public-versus-private distinction is often tested directly.
- Standardisation is what allows exchange trading and liquidity; it does not by itself eliminate counterparty risk — that is achieved separately, through the clearing corporation acting as central counterparty.
Check yourself
1.Why did futures contracts emerge as an alternative to forward contracts?
- a)Because forward contracts could not fix a price in advance
- b)To address concerns of counterparty default, as the Exchange guaranteed the performance of the contract
- c)Because forwards could not be customised to the parties' needs
- d)Because forwards required full payment upfront
Show the answer
Answer: (b) To address concerns of counterparty default, as the Exchange guaranteed the performance of the contract
⚠️ "FUTURES EMERGED AS AN ALTERNATIVE FINANCIAL PRODUCT TO ADDRESS THESE CONCERNS OF COUNTERPARTY DEFAULT, AS THE EXCHANGE GUARANTEED THE PERFORMANCE OF THE CONTRACT IN CASE OF THE FUTURES."
The problem being solved: ⚠️ "MORE OFTEN THAN NOT, THESE FORWARD CONTRACTS WERE NOT HONORED BY EITHER OF THE CONTRACTING PARTIES DUE TO PRICE CHANGES AND MARKET CONDITIONS." Both sides faced the same temptation in opposite directions — a seller pulled out if the spot price was more profitable than the contracted price; a buyer backed out if he could get the commodity cheaper in the spot market.
Option (a) is wrong — fixing a future price is exactly what a forward already did. Option (c) inverts the truth: forwards are the MORE customisable instrument, "tailored to accommodate ANY COMMODITY, IN ANY QUANTITY, FOR DELIVERY AT ANY POINT IN THE FUTURE, AT ANY PLACE"; futures gave that flexibility up for standardisation.
Option (d) reverses a note-worthy feature: in a forward, ⚠️ "GENERALLY, NO CASH TRANSFER OCCURS WHEN THE CONTRACT IS SIGNED... THE BUYER PAYS NO MONEY UPFRONT." And that is part of the problem — with nothing at stake, walking away costs nothing.
Where this is taught
Free preparation for NISM Series XVIRelated terms
- Tick sizeThe smallest price change a contract may be quoted in — prices move only in whole multiples of it, and it differs from one commodity to another.
- Compulsory deliveryA delivery logic under which every position still open at expiry must give or take physical delivery — neither side can elect to settle in cash.
- Options on GoodsA European option whose exercise devolves directly into delivery of and payment for the physical commodity, rather than into a futures position.
- Quotation factorThe physical unit a commodity is quoted in on the exchange — Rs per 10 grams for gold, Rs per kilogram for zinc — one of the three inputs that convert a one-tick price move into rupees.
- Osaka Rice ExchangeThe first known organised futures market, set up in Japan in 1730, where rice bills issued against stored rice turned from title certificates into a right to future delivery at the current price.
- Premium and discount for qualityThe price adjustment when delivered goods differ from the contract's quality specification — a 1:2 discount on castor seed below 47%, and contract rate times 999/995 for .999 gold on a .995 basis.