Futures

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Futures

Futures are standardized derivative contracts that obligate the buyer to purchase—and the seller to deliver—an underlying asset at a predetermined price on a specified future date. They are used for speculation, hedging, and price discovery across a wide range of assets.

How futures work

  • Contracts are standardized by quantity, quality (when applicable), and expiration date so they can be traded on exchanges.
  • Each contract specifies a delivery month. The nearest-expiration contract is called the front-month and usually has the most liquidity.
  • Most futures are marked-to-market daily: gains and losses are settled each trading day through margin accounts.
  • Settlement can be:
  • Cash-settled (common for stock index futures), where profit or loss is paid in cash at expiration.
  • Physically delivered (common for many commodity futures), where the underlying asset is delivered.

Common underlying assets

  • Equity futures (single-stock or groups of stocks)
  • Stock index futures (e.g., S&P 500)
  • Commodity futures (crude oil, natural gas, agricultural products)
  • Precious metals (gold, silver)
  • Energy products (gasoline, heating oil)
  • Interest rate futures (Treasuries, bond futures)
  • Currency futures (euro, pound, yen)
  • Cryptocurrency futures (Bitcoin, Ethereum)

Speculation and leverage

  • Futures let traders gain exposure to an asset with a fraction of the contract’s notional value by posting margin.
  • Example of leverage risk: if an index futures contract is sized at $50 × index level and the index is 5,000, one contract equals $250,000 notional. With a 10% initial margin, a trader posts $25,000. A 10% move against the position would wipe out that margin.
  • Traders can take long positions (betting prices will rise) or short positions (betting prices will fall). Before expiration, positions can be closed by taking the opposite trade.

Hedging with futures

  • Corporations and portfolio managers use futures to lock in prices or hedge exposure.
  • Example: a $100 million portfolio tracking the S&P 500 can be hedged by selling an appropriate number of S&P futures contracts. If the index falls, losses in the portfolio are offset by gains in the short futures position; if the index rises, the portfolio gains while the futures position loses, which is the intended tradeoff when hedging.

Advantages

  • Leverage: control large positions with relatively small capital.
  • Liquidity and transparency: exchange-traded contracts are standardized and centrally cleared.
  • Hedging: effective tool to manage price risk for producers, consumers, and investors.
  • Broad coverage: available for many asset classes and global markets.

Disadvantages and risks

  • Leverage magnifies losses; investors can lose more than their initial margin.
  • Daily mark-to-market can create rapid margin demands (margin calls).
  • Hedging can limit upside potential—profits in the underlying may be offset by losses in the futures position.
  • Complexity: requires understanding contract specifications, expiry cycles, and rollover mechanics.

Regulation

  • Futures markets are regulated to protect market integrity and participants. In the U.S., the Commodity Futures Trading Commission (CFTC) oversees futures trading and enforces rules against abusive practices and fraud.

Key differences from options and forwards

  • Options give a right, not an obligation; futures impose a binding obligation.
  • Forwards are customizable OTC agreements; futures are standardized and exchange-traded, with daily clearing and margining.

Frequently asked questions

  • Why trade futures instead of stocks?
  • Futures allow higher leverage and often trade in extended hours, giving greater capital efficiency and flexibility—but with higher risk.
  • Which is more profitable, futures or options?
  • Profitability depends on strategy, market view, and risk tolerance. Futures offer straightforward exposure with higher leverage; options limit downside (for buyers) but require correct timing and volatility assumptions.
  • What happens at expiration?
  • Depending on the contract, positions are either cash-settled or settled by physical delivery. Most financial index futures are cash-settled; many commodity contracts may require delivery unless the position is closed beforehand.

Bottom line

Futures are powerful instruments for speculation and risk management. They provide leverage, liquidity, and precise exposure to many asset classes, but they also introduce significant risks—primarily from leverage and daily settlement. Successful use of futures requires careful risk management, understanding contract specifications, and disciplined margin management.