What Is a Future?

A futures contract is an agreement to buy or sell a specific amount of something, at a price agreed today, on a set date in the future. The "something" can be a commodity like oil or wheat, a financial asset like a stock index or government bond, a currency or Bitcoin. Futures trade on regulated exchanges, and every contract has standard terms, so a contract bought by one trader is identical to one sold by another.

A simple example#

A wheat farmer expects to harvest 5,000 bushels in September and worries prices will fall before then. A bakery expects to buy wheat in September and worries prices will rise. In June, they agree through the futures market on a price of $6.00 a bushel for September delivery.

• If wheat falls to $5.00 by September, the farmer is protected: the futures position gains, offsetting the lower price for the crop.
• If wheat rises to $7.00, the bakery is protected in the same way.

Both have removed uncertainty. This is hedging, the original purpose of futures. See Hedging.

How futures trading works today#

Most futures traders never deliver or receive anything. They close positions before expiry and take the gain or loss in cash. Many financial futures, such as stock index futures, are settled in cash and cannot be delivered at all.

Margin and leverage#

To open a futures position you deposit initial margin, a fraction of the contract's full value set by the exchange and your broker. If losses take your account below the maintenance margin, you must add money or the position is closed. See Futures Margin: Initial and Maintenance.

That leverage is what makes futures powerful and dangerous. Gains and losses are large relative to the deposit, and a fast move can cost more than the margin posted.

Marking to market#

Every day, the exchange settles each open contract at that day's settlement price. If your position gained, cash is added to your account; if it lost, cash is removed. This prevents losses from piling up unseen and is why futures accounts need spare cash beyond the initial margin. See Mark-to-Market.

What futures are traded on#

• Stock indexes: S&P 500, Nasdaq 100, Dow, Russell 2000 and international indexes.
• Interest rates and bonds: Treasury futures and short term rate futures.
• Energy: crude oil, natural gas, gasoline and heating oil.
• Metals: gold, silver, copper.
• Agriculture: corn, wheat, soybeans, coffee, sugar, cattle.
• Currencies: euro, yen, pound and others against the dollar.
• Crypto: Bitcoin and Ether futures on regulated exchanges, and perpetual futures on crypto exchanges. See Perpetual Futures.

Futures prices vs spot prices#

A futures price is not the same as today's price, called the spot price. The difference reflects storage costs, interest rates and expected supply and demand. When later contracts trade above nearer ones, the market is in Contango; when they trade below, it is in Backwardation.

Risks#

• Leverage: losses can exceed your initial deposit.
• Gaps: prices can jump overnight or on news, past your stop.
• Expiry and rolling: positions must be closed or rolled to a later month before expiry. See Rolling Futures Contracts.
• Delivery: for physically settled contracts, holding too long can create delivery obligations. See Physical Delivery vs Cash Settlement.

Before going further, it helps to understand what a contract actually is; see What Is a Contract?. To compare futures with options side by side, read Futures vs Options.

Frequently asked questions#

What is the difference between futures and options?#

A futures contract obliges both sides to complete the trade at the agreed price. An option gives the buyer the right, but not the obligation. See What Is an Option?.

Do I have to take delivery of oil if I trade oil futures?#

Not if you close or roll your position before the delivery period. Most retail brokers close positions automatically before that point.

How much money do I need to trade futures?#

It depends on the contract. Micro contracts can require only a few hundred to a few thousand dollars of margin, but you should hold extra funds to absorb normal daily losses.

Sources#

• CME Group, E-mini S&P 500 futures contract specifications
• U.S. Commodity Futures Trading Commission, Learn and protect