Futures contract
What is Futures contract?
A futures contract is a standardized exchange-traded agreement obligating parties to transact or cash-settle a specified underlying exposure at a future time under clearinghouse rules.
Futures exposure should be reported using contract value, delta, margin, and stress cash requirement rather than treating margin as invested principal. Hedgers must monitor basis between the contract and real exposure, while investors rolling contracts must distinguish spot return from curve return. A liquid contract in normal conditions can still gap, hit limits, or demand collateral when portfolio liquidity is weakest.
How futures work
The exchange specifies underlying, quantity, quality, delivery location, contract months, tick, settlement, and position rules. Buyers take long exposure and sellers short exposure. Most positions are offset before delivery, but physical delivery remains possible for applicable contracts. Central clearing reduces bilateral counterparty exposure but does not eliminate default, operational, or systemic risk.
Margin and daily settlement
Futures require initial margin and variation margin rather than full notional payment. Positions are marked to market, so losses can trigger urgent cash calls. Margin is performance collateral, not maximum loss. Leverage arises because notional exposure can greatly exceed posted capital, allowing rapid loss beyond the original deposit when markets gap.
Example
A contract represents 1,000 units and price rises $3. A long gains $3,000 and a short loses $3,000 before fees. If initial margin was $2,000, the percentage change on margin is large even though underlying moved modestly. Contract value, tick value, and margin must never be confused.
Uses and return
Futures hedge prices, equitize cash, adjust beta, manage duration or currency, and express directional or relative views. A rolled futures return reflects spot movement, curve and basis, collateral return, and trading cost. Convergence toward settlement can differ from an investor's expected spot exposure, especially for commodities with storage, financing, location, or quality effects.
Risks and practical checklist
Risks include leverage, gap, margin, basis, curve, liquidity, delivery, limit moves, clearing, and operational failure. Confirm contract code, month, multiplier, tick, settlement, first notice, last trade, currency, and margin. Establish roll and collateral policy, monitor position limits, and stress cash needs. Close or prepare delivery well before deadlines rather than assuming a broker will manage it safely.
Also known as: future
Sources and further reading
- CFTC Glossary, U.S. Commodity Futures Trading Commission
- Futures Market Basics, U.S. Commodity Futures Trading Commission