A futures contract is a standardised agreement to buy or sell an asset at a predetermined price on a specified future date. These contracts are traded on regulated exchanges and are commonly used in forex, commodities, stocks, and indices for hedging and speculation.

Understanding Futures Contracts

Futures contracts allow traders and investors to lock in prices for assets to be delivered at a future date. Unlike forward contracts, which are private agreements, futures contracts are standardised and regulated, reducing counterparty risk.

For example, if an oil producer wants to secure a fixed price for its future production, it can sell futures contracts. A buyer, such as an airline company, can purchase these contracts to hedge against rising fuel costs.

Key Features of a Futures Contract

• Standardised Contracts – Futures have predefined contract sizes, expiration dates, and settlement methods.
• Exchange-Traded – Futures are traded on major exchanges like the Chicago Mercantile Exchange (CME) and Intercontinental Exchange (ICE).
• Margin Requirements – Traders must deposit an initial margin, and positions are adjusted daily based on price movements.
• Mark-to-Market – Profits and losses are settled daily instead of waiting until expiration.
• Hedging and Speculation – Businesses use futures to hedge against price changes, while traders speculate on price movements.

Types of Futures Contracts

1. Forex Futures – Contracts to buy or sell a currency pair at a future date.
2. Commodity Futures – Contracts on commodities like oil, gold, and agricultural products.
3. Stock Index Futures – Contracts based on stock market indices such as the S&P 500.
4. Interest Rate Futures – Contracts based on government bonds and treasury rates.
5. Energy Futures – Contracts on crude oil, natural gas, and electricity.

How Futures Contracts Work

1. Opening a Position – A trader buys or sells a futures contract based on price expectations.
2. Margin and Leverage – Traders deposit margin to control a larger contract value.
3. Daily Settlement – Gains and losses are settled daily through mark-to-market adjustments.
4. Expiration and Settlement – At expiry, contracts are either cash-settled or physically delivered.

For example, if a trader buys a GBP/USD futures contract expecting the British pound to rise, they can profit if the price moves in their favour before expiration.

Common Challenges Related to Futures Contracts

• High Leverage Risks – Futures trading involves leverage, which can amplify losses.
• Price Volatility – Market fluctuations can lead to significant gains or losses.
• Contract Expiry – Traders must manage expiring contracts and roll them over if needed.
• Margin Calls – If losses exceed the margin, traders must deposit additional funds.

How to Trade Futures Contracts Successfully

• Understand Market Fundamentals – Research economic data, central bank policies, and supply-demand factors.
• Manage Risk – Use stop-loss orders and position sizing to control losses.
• Monitor Expiry Dates – Roll over contracts if you plan to hold long-term positions.
• Combine with Technical Analysis – Use chart patterns and indicators to time entries and exits.

FAQs

What is a futures contract in trading?

A futures contract is a legal agreement to buy or sell an asset at a fixed price on a future date.

How do futures contracts differ from forward contracts?

Futures contracts are standardised and traded on exchanges, while forward contracts are private agreements.

What are margin requirements in futures trading?

Margin is the collateral traders must deposit to open and maintain a futures position.

How does mark-to-market work in futures contracts?

Profits and losses are settled daily, adjusting traders’ account balances based on price changes.

What happens when a futures contract expires?

It is either physically delivered or cash-settled, depending on the contract type.

Can futures contracts be closed before expiry?

Yes, traders can exit positions at any time before expiration by taking the opposite trade.

Why do traders use futures contracts?

Futures are used for hedging against price risks or speculating on market movements.

Are futures contracts risky?

Yes, due to leverage and market volatility, futures trading carries significant risks.

What is rolling over a futures contract?

Rolling over involves closing an expiring contract and opening a new one for a later date.

Which markets offer futures contracts?

Major exchanges include CME, ICE, and Eurex, covering forex, commodities, and stock indices.

Futures contracts are powerful tools for managing market risks and leveraging price movements. However, they require careful risk management and an understanding of market dynamics.