Futures

Standardized contracts to buy or sell an asset at a future date and price.

A futures contract is a standardized legal agreement to buy or sell a specific asset—such as a commodity, currency, or stock index—at a predetermined price at a specified time in the future. These contracts trade on organized exchanges, which act as intermediaries to guarantee performance and eliminate counterparty risk. Unlike forward contracts, which are customized and traded over-the-counter, futures are highly liquid and have standardized terms regarding quantity, quality, and delivery dates. To trade futures, investors do not pay the full value of the contract upfront. Instead, they deposit a fraction of the total value, known as initial margin, and must maintain a minimum balance, known as maintenance margin. Because the contracts are marked-to-market daily, gains and losses are settled at the end of every trading day, with funds transferred between the buyer's and seller's accounts based on price movements. Investors and traders use futures for two primary purposes: hedging and speculation. Hedgers, such as farmers or airlines, use futures to lock in prices and protect themselves against adverse price movements in the physical commodities they rely on. Speculators, on the other hand, use futures to profit from price changes, leveraging their capital to gain large exposure with a relatively small upfront margin. While leverage can amplify returns, it also introduces significant risk. A small price movement against a trader's position can result in substantial losses, potentially exceeding the initial margin deposited and triggering a margin call. Additionally, retail investors must be aware of the difference between cash-settled contracts (where only cash changes hands at expiration) and physically settled contracts (which require the actual delivery of the underlying asset).

An investor wants to speculate on the price of gold. They buy one gold futures contract representing 100 troy ounces at a price of $2,000 per ounce, representing a total contract value of $200,000. The exchange requires an initial margin of 5%, or $10,000. If the price of gold rises to $2,050 per ounce, the contract value increases to $205,000. The investor's profit is $5,000 ($205,000 - $200,000), representing a 50% return on their $10,000 margin, excluding transaction fees.