What is a futures contract? Understand futures contracts, trading, and applications in one article.

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You can think of futures as a type of standardized legal agreement. Futures contracts are traded on regulated exchanges, specifying the purchase or sale of an asset at an agreed-upon price at a specific time in the future. Each contract clearly defines the quantity, quality, and delivery time, ensuring transparency and fairness. The global futures market continues to grow, with futures trading volume reaching 137 billion contracts in 2023, and 2024 setting new records. You only need to pay a portion of the contract value as margin to participate in large-scale asset trading, but this also comes with higher risks.

Key Takeaways

• Futures contracts are standardized legal agreements that allow buying or selling specific assets at a predetermined price in the future.
• When participating in futures trading, investors only need to pay a portion of the margin to control large assets, but they must be mindful of risks.
• The futures market helps form judgments about future prices through a price discovery mechanism, reducing market uncertainty.
• Investors can use futures contracts to hedge risks, lock in future costs or profits, and protect their interests.
• Understanding the types of risks in futures trading and management strategies can help investors make more informed decisions.

Futures Definition

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Basic Concepts

You can view a futures contract as a standardized, legally binding financial agreement. The U.S. Commodity Futures Trading Commission (CFTC) and the European Securities and Markets Authority (ESMA) both clarify that futures contracts allow you to buy or sell specific underlying assets, such as oil, gold, or stock indices, at a predetermined price in the future.

Futures contracts are typically traded on futures exchanges. You can use them to hedge against price fluctuations, speculate, or manage risks. Each contract specifies the type of commodity and trading volume.

The basic elements of a futures contract include:

• Underlying Asset: The object you can trade, which may be a commodity, financial instrument, or cryptocurrency.
• Contract Size: The amount of the asset represented by each contract. For example, one crude oil futures contract might represent 1,000 barrels of oil.
• Expiration Date: Each contract has a clear expiration date, usually set monthly or quarterly.
• Price: The contract specifies the price at which the asset will be bought or sold in the future.

In essence, a futures contract is an agreement between you and another party to buy or sell a certain quantity of an underlying asset at a specific price on a particular date in the future.

Spot vs. Futures

When learning about futures, you often hear the term “spot.” The spot market and the futures market have distinct differences. The following table can help you quickly understand their differences:

When you buy or sell goods in the spot market, delivery is usually completed immediately. In the futures market, you can lock in a price in advance and settle on a future date. This mechanism allows you to manage risks from price fluctuations or participate in speculation for profit.

Futures Contracts

Contract Features

When participating in the futures market, you will first encounter the standardized features of futures contracts. Each futures contract is legally binding, clearly defining the rights and obligations of both buyers and sellers. You can trade these contracts on regulated exchanges, ensuring transparency and openness in transactions.

The following table summarizes the key legal elements of futures contracts:

In practice, you will find that the standardization of futures contracts is reflected in the following aspects:

• Contract Underlying: The objects you can trade, such as commodities or financial instruments, are uniformly specified by the exchange.
• Delivery Date: Each contract has a clear expiration date, typically set for a specific day each month or quarter.
• Margin System: You only need to pay a portion of the initial margin to open a position. For example, in the U.S. market, if a crude oil futures contract has a notional value of $70,000 USD, the initial margin might only be $7,000 USD, achieving a leverage ratio of 10:1. You can control a larger trading scale with smaller capital.
• Leverage Effect: The leverage in futures trading allows you to amplify profits, but it also magnifies risks. You need to constantly monitor your account balance to avoid margin calls due to market fluctuations.

At the time of delivery, you can choose physical delivery or cash settlement. Physical delivery requires the actual transfer of the underlying asset, meeting specific delivery locations and quality standards. Cash settlement is based on the final market price valuation, eliminating the need for physical delivery, making the process more convenient.

Tip: The margin requirement in the futures market is typically 2% to 12% of the contract’s notional value. You need to allocate funds reasonably based on the contract’s volatility and risk characteristics.

Contract Types

In the global futures market, you will encounter various types of futures contracts. Different contract types correspond to different underlying assets and trading needs. The following table shows common futures contract types and their underlying assets:

When trading, in addition to common commodity and stock index futures, you will encounter contracts with different settlement methods:

• Delivery Contracts: At expiration, you must perform physical delivery or cash settlement, suitable for businesses or investors needing to hedge actual asset price risks.
• Perpetual Contracts: These contracts have no fixed expiration date, common in the cryptocurrency market. You can close positions at any time, offering greater flexibility.
• Options Contracts: Although similar to futures contracts, you have the right, not the obligation, to buy or sell an asset at a specific price on a future date. Options contracts provide additional risk management tools.

When choosing futures contract types, you need to align them with your risk tolerance and investment goals, allocating different contract products appropriately. Regardless of the type, you must fully understand the trading rules and settlement methods to ensure capital safety.

Trading Process

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Opening and Closing Positions

When trading in the futures market, you first need to learn how to open and close positions. Opening a position involves buying or selling a futures contract based on your judgment, establishing a new position. Closing a position involves executing a trade in the opposite direction to end an existing position, realizing profits or losses. Common operations include:

• You can close a position at any time through an opposite trade to lock in profits or stop losses.
• If you don’t want to deliver at the contract’s expiration, you can choose to “roll over to a new contract,” transferring the current position to a contract for the next month.
• If you hold the position until expiration, the system will automatically settle or deliver.

Tip: Before placing an order, you should familiarize yourself with basic concepts, develop a trading strategy, choose the appropriate contract and month, and understand how account funds operate to better manage risks.

Margin and Leverage

Futures trading uses a margin system. You only need to pay a small portion of the contract’s total value as initial margin to participate in large-scale trading. For example, in the U.S. market, a Bitcoin futures contract worth $50,000 USD may require only $5,000 USD in margin, achieving a leverage ratio of 10:1. Key points include:

• Initial Margin: The minimum capital required to open a position, typically higher than the maintenance margin.
• Maintenance Margin: The minimum funds you must keep in your account. If your account balance falls below this level, you will receive a margin call.
• Margin Call: When market fluctuations cause losses and your account funds fall below the maintenance margin, you must add funds promptly, or your position may be forcibly closed.

Leverage ratios vary for different assets. Stock index futures typically have leverage of 10:1 to 20:1, while commodity futures range from 5:1 to 15:1. Leverage can amplify profits but also magnifies losses, so you must pay special attention to risk management.

Delivery Process

After a futures contract expires, you need to complete delivery. Delivery methods are divided into cash settlement and physical delivery. The following table compares the main differences between the two delivery methods:

In most financial futures, you will encounter cash settlement, where profits and losses are settled based on the market price difference without the need for physical delivery. Commodity futures, such as crude oil or wheat, may involve physical delivery, requiring actual delivery and storage.

Market Functions

Price Discovery

In the futures market, you can observe the price discovery process. The futures market aggregates expectations and information from numerous buyers and sellers, helping to form judgments about future prices. You will find that futures prices often reflect the market’s expectations of future supply and demand, significantly impacting the spot market. The following table summarizes the role of the futures market in price discovery:

You can obtain more transparent price information through the futures market. Studies show that active futures markets can promote the convergence of spot and futures prices, improving the efficiency of price formation. For example, agricultural futures markets help farmers and businesses better understand market supply and demand, reducing price uncertainty.

Risk Hedging

You can use futures contracts to hedge risks from price fluctuations. Businesses and investors often lock in future costs or profits by buying or selling futures contracts. Common hedging methods include:

• Airlines, during oil price fluctuations, can buy fuel futures contracts to secure future fuel costs. For example, in 2022, European airlines successfully offset rising operational costs from oil price increases through hedging contracts.
• Farmers, concerned about falling agricultural product prices, can sell futures contracts. If market prices drop, profits from the futures contracts can offset losses from spot sales.
• U.S. companies expecting future euro payments can hedge exchange rate risks by selling euro futures contracts. If the euro depreciates, gains in the futures market can offset exchange losses.
• Investors holding stock portfolios can sell stock index futures contracts to hedge against market downturns. For example, selling /ES futures contracts can hedge approximately 30% of portfolio risk.

Through these methods, you can effectively reduce the impact of market fluctuations on your business or investments.

Speculation and Arbitrage

In the futures market, you can also observe speculation and arbitrage activities. Speculators predict market trends, buying or selling futures contracts to pursue higher returns. Arbitrageurs exploit price differences between different markets or contracts to earn risk-free profits. Common arbitrage strategies include:

• Spot-Futures Arbitrage: You can buy an asset in the spot market while selling the corresponding contract in the futures market to profit from price differences.
• Triangular Arbitrage: You can exploit exchange rate differences in the forex market through currency loop conversions to gain profits.
• Merger Arbitrage: During corporate mergers, you can buy the target company’s stock and short the acquiring company’s stock to profit from price differences.

Studies show that speculative activities provide liquidity to the market but may increase short-term volatility. Trading restrictions help reduce price fluctuations and enhance the market’s price discovery function. When participating, you need to understand these strategies and risks to make rational decisions.

Risks and Participation

Risk Types

When participating in futures trading, you will encounter various risks. Common risks include:

• Market Risk: Changes in the financial market environment can cause price fluctuations, affecting your investment returns. For example, sharp fluctuations in stock prices, interest rates, exchange rates, and commodity prices can lead to losses.
• Credit Risk: If a counterparty fails to fulfill contract obligations, you may face default losses.
• Operational Risk: Operational errors, system failures, or flawed processes can lead to financial losses.
• Leverage Risk: The leverage effect in futures trading amplifies both profits and losses. In early 2025, several trend-following funds in the U.S. market suffered significant losses due to market volatility, such as BlueTrend declining 17%, Transtrend losing 17.5%, and AHL Alpha dropping 7.6%.
• Liquidity Risk: When market liquidity is insufficient, you may struggle to close positions promptly or at ideal prices.
• Settlement and Delivery Risk: All transactions require settlement at expiration, and issues in the process may affect capital safety.

Risk Management

You can manage futures risks through various tools and strategies. The following table summarizes commonly used risk management methods:

You can also set realistic profit targets and stop-loss points, calculate appropriate position sizes, and ensure a reasonable risk-reward ratio. Major U.S. futures exchanges require trading platforms to establish risk control mechanisms to prevent market manipulation and system anomalies, ensuring trading safety.

Investor Participation

Before participating in the futures market, you need to assess your financial situation and risk tolerance. You should understand the rights and obligations of each contract and carefully read the risk disclosure documents provided by brokers. In the U.S. market, opening an account typically requires you to provide information on income, net worth, and investment experience, as well as undergo identity verification. You should be clear about the maximum loss you can afford and communicate promptly with your broker or regulatory authorities if issues arise. Before opening an account, ask questions and gather information to ensure transparency.

You have now learned about the standardized nature of futures contracts, leverage mechanisms, and the trading process. Futures not only allow you to control large assets with smaller capital but also protect yourself from price fluctuations through hedging strategies. In practice, you should reasonably control position sizes, set stop-loss orders, and diversify investments to enhance risk management capabilities. Mastering these core concepts will help you make more informed financial decisions and achieve long-term stability.

FAQ

How is futures trading different from stock trading?

In the futures market, you trade contracts for future assets, typically with leverage. In the stock market, you directly buy or sell company shares without leverage. Futures have expiration dates, while stocks can be held long-term.

How much capital is needed for futures trading?

You only need to pay a portion of the contract value as margin. For example, a crude oil futures contract worth $70,000 USD may require an initial margin of $7,000 USD.

What happens after a futures contract expires?

After a futures contract you hold expires, the system will automatically settle it. You may need to perform cash settlement or physical delivery, depending on the contract type.

Can futures contracts be closed at any time?

You can close a position at any time during trading hours. You simply need to execute a trade in the opposite direction to end the position without waiting for the contract to expire.

What are the main risks in futures trading?

You will face market risk, leverage risk, and liquidity risk. Price fluctuations may lead to losses. You need to set reasonable stop-loss orders and control position sizes.

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