What Are Futuurit and How Do They Work in Trading?

Futures are financial contracts that obligate the buyer to purchase, or the seller to sell, an asset at a predetermined price on a specified future date. They allow investors to hedge against price fluctuations or speculate on market movements and are widely used across various markets, from commodities to financial instruments.

Contract Specifications

Each futures contract follows standardized terms to ensure consistency across trades. Contract size determines the quantity of the underlying asset being traded. For example, a crude oil futures contract on the CME Group’s NYMEX represents 1,000 barrels of oil, while a gold futures contract on COMEX corresponds to 100 troy ounces. Standardized sizes improve liquidity and simplify trading.

Price quotation and tick size are also predetermined. Tick size refers to the smallest price movement a contract can make. S&P 500 futures, for instance, have a tick size of 0.25 index points, with each tick valued at $12.50 per contract. This ensures price changes occur in uniform increments, making it easier for traders to calculate potential gains or losses.

Futures contracts have fixed expiration cycles, typically monthly or quarterly. The most actively traded contracts follow a March, June, September, and December cycle, known as the quarterly expiration cycle. Traders must monitor these dates, as open positions must be closed or rolled over before expiration to avoid physical delivery or settlement obligations.

Types of Underlying Assets

Futures contracts derive their value from an underlying asset, which can be a physical commodity or a financial instrument. These assets determine the contract’s pricing and settlement. The most commonly traded categories include commodities, indexes, and currencies.

Commodities

Commodity futures cover tangible goods such as agricultural products, energy resources, and metals. These contracts help producers and consumers manage price volatility. A wheat farmer, for example, might sell wheat futures to lock in a price before harvest, protecting against potential declines. A food manufacturer might buy wheat futures to secure a stable cost for raw materials.

Energy futures, such as crude oil and natural gas, are among the most actively traded. Crude oil prices fluctuate based on geopolitical events, OPEC production decisions, and seasonal demand. The West Texas Intermediate (WTI) crude oil futures contract, traded on NYMEX, represents 1,000 barrels of oil. A $1 price movement in WTI futures equates to a $1,000 change in contract value.

Metals futures, including gold, silver, and copper, are often used as inflation hedges or safe-haven investments. Gold futures, traded on COMEX, are priced in U.S. dollars per troy ounce, with a standard contract covering 100 ounces. Investors use these contracts to speculate on price movements or hedge against currency depreciation and economic uncertainty.

Indexes

Index futures allow traders to gain exposure to broad market movements without buying individual stocks. These contracts are commonly used for hedging portfolio risk or speculating on market trends.

One of the most widely traded index futures is the E-mini S&P 500, which tracks the performance of 500 large-cap U.S. companies. Each contract represents $50 times the index value, meaning if the S&P 500 is at 4,500 points, the contract’s notional value is $225,000. A one-point move in the index results in a $50 gain or loss per contract.

Other popular index futures include the Nasdaq-100, which focuses on technology and growth stocks, and the Dow Jones Industrial Average, which represents 30 blue-chip companies. These contracts provide traders with efficient ways to manage exposure to market fluctuations, particularly during earnings seasons or economic data releases.

Currencies

Currency futures allow traders to speculate on exchange rate movements or hedge against foreign exchange risk. Unlike the decentralized forex market, these contracts are standardized and traded on regulated exchanges.

Major currency futures include the Euro FX, British Pound, and Japanese Yen, all traded on the CME Group. The Euro FX futures contract, for example, represents 125,000 euros, with prices quoted in U.S. dollars per euro. If the contract price moves from 1.1000 to 1.1050, the total change in value is $625 (0.0050 x 125,000).

Businesses engaged in international trade use currency futures to protect against unfavorable exchange rate fluctuations. A U.S. company expecting to receive payments in euros might sell Euro FX futures to lock in a favorable exchange rate, reducing the risk of currency depreciation. Similarly, an importer purchasing goods from Japan might buy Japanese Yen futures to hedge against a stronger yen increasing costs.

Margin Requirements

Futures trading requires participants to post margin, which acts as a financial safeguard to ensure they can meet their contractual obligations. Unlike traditional stock purchases, where investors pay the full price upfront, futures margins function as a good-faith deposit, allowing traders to control a larger position with a fraction of the total contract value. This leverage amplifies potential gains but also increases risk.

Initial margin is the amount a trader must deposit to open a position. This requirement is set by the exchange and varies depending on the volatility and risk associated with the underlying asset. In 2024, the CME Group requires approximately $11,000 in initial margin for one E-mini S&P 500 contract, while a crude oil futures contract may require around $6,000. These amounts are periodically adjusted based on market conditions.

Once a position is established, traders must maintain a minimum balance known as the maintenance margin. If losses reduce the account balance below this threshold, the trader receives a margin call, requiring additional funds to bring the account back to the initial margin level. Failure to meet a margin call can result in the broker liquidating the position.

Leverage magnifies both profit potential and downside risk, making risk management essential. Many traders use stop-loss orders to limit potential losses or hedge positions by holding offsetting contracts. Some brokers offer risk-based margining, where margin requirements adjust based on portfolio composition, potentially reducing capital requirements for diversified positions.

Settlement Procedures

Futures contracts can be settled in two ways: cash settlement or physical delivery. The method depends on the specific contract and market.

Cash settlement is common for financial futures, such as interest rate or volatility index contracts, where delivering the underlying asset is impractical. Instead of exchanging the actual asset, the contract is closed by paying or receiving the difference between the contract price and the final settlement price determined by the exchange.

Physical delivery occurs when the contract requires the transfer of the underlying asset upon expiration. This process is more prevalent in commodity markets, such as agricultural products and industrial metals. Exchanges set strict delivery procedures, specifying the acceptable grade, location, and time frame for the asset’s handover. For example, a trader holding a futures contract on Chicago Board of Trade (CBOT) corn must either accept delivery at an approved warehouse or offset the position before expiration.

Roles of Clearinghouses

Clearinghouses act as intermediaries between buyers and sellers, mitigating counterparty risk and ensuring that both parties fulfill their contractual obligations. By guaranteeing trade performance, clearinghouses enhance market stability and investor confidence.

To manage risk, clearinghouses require all market participants to post margin and mark positions to market daily. This ensures unrealized gains and losses are settled in real time. If a trader’s position moves against them, they must provide additional funds to maintain margin requirements. Clearinghouses also maintain default funds as a financial backstop in case a member fails to meet obligations.

Beyond risk management, clearinghouses streamline trade processing by netting transactions and reducing the number of individual settlements. This consolidates multiple trades into a single obligation, minimizing capital requirements and improving liquidity. Major clearinghouses, such as CME Clearing and ICE Clear, play a central role in global derivatives markets, ensuring that futures contracts are executed and settled efficiently. Their involvement allows traders to focus on market strategies rather than counterparty risk, making futures trading more accessible and efficient.