A futures contract is a standardized agreement between two parties to buy or sell a specific asset at a specific price on a set future date. Both sides are legally obligated to follow through when the contract expires — no backing out allowed (although most traders unwind their position prior to expiry).
These contracts trade on regulated exchanges where a clearinghouse guarantees everyone honours their obligations, which is why everyone from wheat farmers to hedge fund managers relies on them. Below, we'll cover how futures pricing works, the different types of contracts available, and what distinguishes futures from other derivatives like options.
What is a futures contract?
A futures contract is a standardized agreement to buy or sell a specific asset at a specific price on a set future date. Both the buyer and seller are legally obligated to fulfil the contract when it expires. Unlike informal agreements, futures trade on regulated exchanges where a clearinghouse guarantees that both parties will honour their commitments.
Here's a simple way to think about it: imagine a wheat farmer in Saskatchewan who wants to lock in a price for the crop being planted in spring. The farmer sells a futures contract agreeing to deliver wheat at $8 per bushel in September. A bread manufacturer on the other side of that trade agrees to buy at that price. No matter what happens to wheat prices over the summer, both parties have certainty about the transaction.
The exchange sits in the middle, making sure everyone plays by the rules. This structure has made futures contracts a cornerstone of global commodity and financial markets for over a century.
Key components of a futures contract
Every futures contract spells out exactly what's being traded and on what terms. The underlying asset could be a physical commodity like crude oil, a financial instrument like a stock index, or a currency like the euro.
Contract size is standardized so everyone knows precisely what they're trading. One crude oil futures contract on the New York Mercantile Exchange (NYMEX) always represents 1,000 barrels. One gold contract on the Chicago Mercantile Exchange (CME) covers 100 troy ounces.
Beyond size, contracts specify:
Delivery date: the month and day when the contract expires
Tick size: the minimum price movement, such as $0.01 per barrel for oil
Settlement: is the contract cash settled, or physically delivered and if so what location and quality are required
Trading hours: when buying and selling can occur
Margin requirements: the amount of cash needs to be held at the clearinghouse
How futures contracts work
When you open a futures position, you're either going long (agreeing to buy at expiration) or going short (agreeing to sell). You don't pay the full contract value upfront. Instead, you deposit margin, which functions as a performance bond.
Margin typically ranges from 5% to 20% of the contract's total value. So if you're trading a contract worth $100,000, you might put down $7,000. This creates leverage, meaning small price movements translate into large percentage gains or losses on your deposit.
Most traders never actually take delivery of anything. Instead, they close positions before expiration by entering an opposite trade. If you bought one December corn contract, you'd sell one December corn contract to exit. The difference between your entry and exit prices determines your profit or loss.
The role of margin in futures trading
Two types of margin matter here.
Initial margin is what you deposit to open a position.
Maintenance margin is the minimum balance you're required to keep while holding that position.
If the market moves against you and your account falls below the maintenance level, you'll receive a margin call. This is a demand to deposit additional funds immediately. Fail to do so, and your broker can liquidate your position without asking.
Critically, a margin call doesn't just ask you to top up to the maintenance level. You're required to restore your account all the way back to the initial margin amount. That distinction matters when you're doing the math.
The math can move quickly. Say you control a $50,000 contract with $5,000 in initial margin and a $4,000 maintenance requirement. If the market drops and your account equity falls to $3,500 ($500 below the maintenance threshold), you'd owe $1,500 right away to stay in the trade. That brings your account back up to the full $5,000 initial margin, not just the $4,000 maintenance floor.
Daily settlement and mark-to-market
Futures accounts work differently than stock accounts. With stocks, your gains and losses stay unrealized until you sell. With futures, your account is settled at the end of every trading day through a process called mark-to-market.
If the market moves in your favour, cash is credited to your account that evening. If it moves against you, cash is debited. This daily settlement reduces risk for the clearinghouse and ensures traders maintain adequate margin throughout the life of a position.
The practical effect? You can't simply wait out a losing position without having capital to cover ongoing losses as they occur.
Types of futures contracts
Futures markets started with agricultural products but have expanded dramatically. Today, contracts exist for everything from soybeans to stock indices to cryptocurrencies. The two broad categories are commodity futures and financial futures.
Commodity futures
Commodity futures cover physical goods.
Agricultural contracts include wheat, corn, soybeans, canola, coffee, and cattle.
Energy contracts cover crude oil, natural gas, gasoline, and heating oil.
Metals contracts include gold, silver, copper, and platinum.
A natural gas futures contract on NYMEX represents 10,000 million British thermal units (MMBtu). Utilities and energy producers commonly use natural gas contracts to manage price swings. Canola futures trade on ICE Futures Canada in 20-metric-ton contracts, serving Prairie farmers and food processors who want price certainty.
Each commodity has its own quirks. Agricultural contracts are heavily influenced by weather and growing seasons. Energy contracts respond to geopolitical events and production decisions. Metals often move with inflation expectations and currency fluctuations.
Financial futures
Financial futures cover intangible assets and are typically cash-settled, meaning no physical delivery occurs. Instead, the difference between the contract price and the settlement price is paid in cash.
Common financial futures include:
Equity indices: S&P 500, Nasdaq-100, S&P/TSX 60
Interest rates: U.S. Treasury bonds, Secured Overnight Financing Rate (SOFR)
Currencies: euro, Japanese yen, Canadian dollar
Micro futures contracts have made financial futures more accessible to individual traders. A micro S&P 500 contract is one-tenth the size of the standard E-mini contract (an electronically traded futures contract sized at a fraction of the standard full-size contract), requiring less margin and reducing the dollar impact of each price tick.
How futures contract pricing works
Futures prices aren't forecasts of where spot prices will land at expiration. Instead, they reflect current spot prices adjusted for the cost of holding the asset until delivery. This relationship is called the cost-of-carry model.
Factors affecting futures prices
When futures prices exceed spot prices, the market is in contango. This situation is typical when storage costs are significant and supplies are adequate. When futures trade below spot prices, the market is in backwardation, often signalling tight current supply or strong immediate demand.
Beyond the cost-of-carry relationship, futures prices respond to supply and demand fundamentals, weather patterns for agricultural commodities, geopolitical events affecting energy supplies, and broader market sentiment. A drought in the U.S. Midwest can send corn futures sharply higher. An OPEC production decision can move oil contracts within minutes.
Calculating futures contract price
Futures prices reflect the spot price plus the cost of carrying the asset until delivery — including financing, storage, and any income the asset generates.
If you want to get technical, the basic pricing formula is: F = S × e^((r+s-c)×t)
The variables break down as follows:
F = futures price
S = current spot price
r = risk-free interest rate
s = storage costs (for physical commodities)
c = convenience yield or expected dividends
t = time to expiration in years
For a stock index future, storage costs don't apply, but expected dividends reduce the futures price relative to spot. For commodities like oil or grain, storage and insurance costs push futures prices higher than spot prices.
Practical uses of futures contracts
The same futures contract serves completely different purposes depending on who's trading it. Hedgers use futures to manage existing price risk. Speculators use futures to profit from anticipated price movements. Both groups depend on each other for the market to function.
Hedging with futures contracts
A canola farmer might sell futures in spring to lock in prices for the fall harvest. If canola prices drop by September, the farmer's crop is worth less in the cash market, but gains on the short futures position offset that loss. This approach is called a short hedge.
On the other side, an airline might buy jet fuel futures to stabilize operating costs. The airline isn't betting on fuel prices; it's converting an unpredictable expense into a known cost. This approach is called a long hedge.
Hedging doesn't eliminate risk entirely. Basis risk, which is the difference between spot and futures prices at expiration, means hedges are rarely perfect. But hedging does transform large, unpredictable price swings into smaller, more manageable variations.
Speculation and trading strategies
Speculators take positions based on their market outlook without any underlying exposure to hedge. A trader who expects oil prices to rise might buy crude oil futures. If prices increase, the trader profits. If prices fall, the trader loses.
Common speculative approaches include directional trading based on price forecasts, spread trading that exploits price relationships between related contracts, and arbitrage that profits from price discrepancies across markets.
The leverage in futures amplifies both potential returns and potential losses. A 10% move in the underlying asset can mean a 100% gain or loss on the margin deposit.
Futures contracts vs. other financial instruments
Futures are one of several derivative instruments available to traders and hedgers. Understanding the differences helps clarify when each might be appropriate.
Feature | Futures | Forwards | Options |
|---|---|---|---|
| Standardization | Yes | No, customized | Yes |
| Trading venue | Exchange | Over-the-counter | Exchange or OTC |
| Obligation | Both parties obligated | Both parties obligated | Buyer has right, not obligation |
| Settlement | Daily mark-to-market | At maturity | At exercise or expiration |
| Counterparty risk | Clearinghouse guarantee | Direct exposure | Clearinghouse for exchange-traded |
Forward contracts offer customization but carry counterparty risk since no clearinghouse guarantees performance. Options provide asymmetric risk profiles where a buyer’s loss is limited to their premium.
Risks and considerations
Futures trading involves substantial risk. The leverage that makes futures capital-efficient also means losses can exceed your initial deposit. A margin call at an inconvenient time can force position closures at unfavourable prices.
Other risks include:
Liquidity risk: difficulty exiting positions in thinly traded contracts
Basis risk: imperfect correlation between futures and spot prices
Delivery risk: unexpected physical delivery obligations if positions aren't closed before expiration
Position sizing, stop-loss orders, and maintaining margin buffers above minimum requirements are common risk management approaches.
Regulatory oversight and protections
In the U.S., the Commodity Futures Trading Commission (CFTC) regulates futures markets, while the National Futures Association (NFA) oversees brokers. In Canada, futures trading falls under provincial securities regulators.
Exchange-traded futures benefit from clearinghouse guarantees that virtually eliminate counterparty default risk. However, regulatory oversight doesn't protect against trading losses. Futures accounts don't carry the same investor protections as securities accounts, and there's no equivalent to Canadian Investor Protection Fund (CIPF) coverage for futures positions.
Are futures contracts right for you?
Futures offer tools for managing price risk and accessing diverse markets with relatively little capital. Businesses use futures to stabilize costs and revenues. Traders use futures to express market views with leverage.
Yet futures aren't investments in the traditional sense. They're trading instruments with defined time horizons and significant leverage. Anyone considering futures trading will benefit from thorough education, practice with simulation accounts, and honest assessment of risk tolerance and available capital.
