What Is a Futures Contract?
A futures contract is a standardized agreement, traded on an exchange, to buy or sell a specific quantity of an asset at a predetermined price on a set future date. Underlyings range from commodities like crude oil, corn, and gold to financial instruments like stock indexes, Treasury bonds, and currencies.
Unlike an option, a futures contract obligates both parties: the buyer must take delivery, or settle in cash, and the seller must deliver, regardless of where the market price ends up. In practice, most positions are closed out before expiration rather than physically delivered.
How It Works
Futures trade through a central clearinghouse that stands between buyers and sellers, virtually eliminating counterparty risk. To open a position, traders post initial margin, a good-faith deposit that is typically a small fraction of the contract's notional value, which creates substantial leverage.
Positions are marked to market daily: gains are credited and losses debited to each trader's margin account every day. If losses push the account below the maintenance margin level, the trader receives a margin call and must add funds or have the position liquidated.
Example
Suppose crude oil futures trade at $80 per barrel and one contract covers 1,000 barrels, an $80,000 notional value. You buy one contract by posting $8,000 of margin. If oil rises to $84, your position gains 4 x 1,000 = $4,000, a 50% return on your margin even though oil rose only 5%.
If oil instead falls to $76, you lose $4,000, half your margin, showing how the same leverage amplifies losses.
Why It Matters
Futures are the main tool producers and consumers use to lock in prices, from farmers hedging harvests to airlines hedging fuel, and futures prices serve as global benchmarks for commodities and rates. They also give investors liquid, low-cost exposure to entire markets, such as S&P 500 index futures.
Futures and commodities desks are core seats in sales and trading, and macro hedge funds express many of their views through futures markets.
