Futures trading lets you buy or sell a contract that locks in a price for an asset on a specific future date. You’re not trading the asset itself, whether that’s crude oil, corn, gold, or a stock index. You’re trading an agreement about what that asset will cost later. This mechanism serves two broad purposes: businesses use it to protect themselves against price swings, and traders use it to profit from those same swings.
What a Futures Contract Actually Is
A futures contract is a standardized agreement between two parties. One agrees to buy and the other agrees to sell a set quantity of an asset at a predetermined price on a specific expiration date. These contracts trade on regulated exchanges like the Chicago Mercantile Exchange (CME), which standardize every detail: the quantity, quality, delivery date, and minimum price movement.
Say a crude oil futures contract covers 1,000 barrels. If you buy one contract at $75 per barrel, you’ve agreed to purchase 1,000 barrels at that price when the contract expires. If oil rises to $80 before expiration, your contract is worth $5,000 more than what you paid. If it drops to $70, you’re down $5,000. Most traders never take delivery of the physical commodity. They close their position before expiration by entering an opposite trade, pocketing the gain or absorbing the loss.
How Leverage and Margin Work
The defining feature of futures is leverage. You don’t pay the full value of the contract upfront. Instead, you deposit a fraction of it, called the initial margin. Exchanges set initial margin requirements that can be as low as 3% to 12% of the contract’s total value. On a contract worth $100,000, that means you might put down $3,000 to $12,000 to control the full position.
This leverage cuts both ways. A small price move in your favor can produce an outsized return on the money you actually deposited. But the same small move against you can wipe out your margin just as fast. If you control $100,000 worth of oil with $5,000 in margin, a 5% drop in price means you’ve lost $5,000, your entire deposit, even though the contract’s value only fell by a modest amount in percentage terms.
Beyond initial margin, there’s a second threshold called maintenance margin, which is lower than the initial amount. This is the minimum balance you must keep in your account while holding the position. If your account dips below it, you’ll face a margin call: a demand to deposit more funds. Brokers are not required to notify you before this happens. In many cases, firms can liquidate your positions automatically, choosing which contracts to sell without your input and without waiting for you to respond. Some brokers issue intraday margin calls and may close positions within hours or even minutes if the market moves sharply against you.
Daily Settlement and Mark-to-Market
Unlike stocks, where your gains and losses exist only on paper until you sell, futures positions are settled every single day. This process is called mark-to-market. At the end of each trading session, the exchange calculates a daily settlement price that reflects the fair market value determined by buyers and sellers during the closing period. Your account is then credited or debited based on how the contract’s price moved that day.
If you bought a contract in the morning and it rose by $500 in value by the close, $500 is deposited into your account that day. If it fell $500, that amount is pulled from your account. This happens every trading day for as long as you hold the position. The practical effect is that you can never let a losing position quietly sit in your account hoping for a recovery. Losses are realized in cash daily, and if those losses push your balance below the maintenance margin, you need to add funds immediately or risk liquidation.
Who Uses Futures and Why
Futures markets exist because businesses need to manage price risk. An airline, for example, might consume millions of gallons of jet fuel each year. A sudden spike in oil prices can devastate its operating costs. By buying crude oil futures, the airline locks in a price today for fuel it will need months from now. Southwest Airlines saved $171 million in jet fuel costs in 2003 through its hedging program and had over 80% of its anticipated 2004 fuel needs hedged at prices capped around $24 per barrel. American Airlines similarly reduced fuel expenses by $149 million in 2003 through futures hedging.
Farmers and food producers use the same strategy from opposite sides. A wheat farmer might sell futures to lock in a price before harvest, protecting against a price drop. A cereal manufacturer might buy wheat futures to guarantee supply costs, protecting against a price spike. Neither party knows where prices will actually land, but both have traded uncertainty for predictability.
Speculators, including individual retail traders, are the other major participants. They have no interest in the underlying commodity. They’re making directional bets on price movements, and the leverage in futures lets them do so with relatively small amounts of capital. Speculators provide liquidity to the market, making it easier for hedgers to find counterparties for their trades.
What You Can Trade
Futures contracts cover a wide range of assets. Commodity futures include energy products (crude oil, natural gas), metals (gold, silver, copper), and agricultural goods (corn, soybeans, wheat, cattle). Financial futures track stock indexes (S&P 500, Nasdaq-100), interest rates (Treasury bonds), and currencies (euro, yen).
For retail traders, smaller contract sizes make futures more accessible. The Micro E-mini S&P 500 contract, for instance, is valued at $5 times the S&P 500 Index. If the index is at 5,400, one Micro E-mini contract is worth $27,000, with a minimum price movement (called a tick) of 0.25 index points, or $1.25 per tick. These micro contracts let individual traders participate in index futures without the capital required for full-size contracts, which can be worth ten or twenty times as much.
How a Trade Plays Out
Here’s the sequence from start to finish. You open an account with a futures broker, deposit funds to cover margin, and choose a contract. Suppose you believe crude oil prices will rise. You buy one crude oil futures contract at $75 per barrel, controlling 1,000 barrels. Your broker requires $6,000 in initial margin.
On day one, oil closes at $75.80. Your position gained $0.80 per barrel across 1,000 barrels, so $800 is credited to your account. On day two, oil drops to $74.50, a $1.30 decline from the previous close. Your account is debited $1,300. Your balance has now fallen below the maintenance margin threshold, triggering a margin call. You deposit additional funds to bring your account back above the required level.
On day five, oil has climbed to $77. You decide to close your position by selling one contract at $77. Your total profit is $2 per barrel times 1,000 barrels: $2,000, minus any commissions and fees. If instead oil had dropped to $73 and you closed, you’d be out $2,000, and that money would already have been pulled from your account through the daily settlement process.
Going Long and Going Short
Futures let you profit from prices moving in either direction. Going long means buying a contract with the expectation that prices will rise. Going short means selling a contract first, with the intention of buying it back later at a lower price. Unlike short selling in the stock market, shorting futures doesn’t require borrowing an asset. You simply enter a sell order to open a position, and the exchange matches you with a buyer.
This makes futures popular for traders who want to bet on declining prices. If you believe the S&P 500 will fall, you can sell an E-mini S&P 500 futures contract. If the index drops, you buy the contract back at the lower price and keep the difference. The margin requirements and daily settlement process work the same way in both directions.
Costs Beyond Margin
Margin is not a fee. It’s your own money held as collateral, and you get it back when you close the position (adjusted for gains or losses). The actual costs of futures trading include commissions charged per contract per trade, exchange fees set by the exchange itself, and the bid-ask spread, which is the small difference between the price buyers are willing to pay and the price sellers are asking. For heavily traded contracts like E-mini S&P 500 futures, spreads are typically very tight. For less liquid contracts, spreads widen and trading costs increase.
Contract Expiration and Rolling
Every futures contract has an expiration date, typically set on a monthly or quarterly cycle. As expiration approaches, traders who want to maintain their position “roll” it forward by closing the expiring contract and opening the next one. This is standard practice for speculators who have no intention of taking delivery. If you hold a commodity futures contract through expiration and don’t close it, you could be obligated to accept physical delivery of, say, 5,000 bushels of corn, though your broker will typically intervene before that happens.
Cash-settled contracts, common for stock index futures, skip physical delivery entirely. At expiration, the exchange simply credits or debits your account based on the final settlement price versus your entry price. Micro E-mini S&P 500 contracts work this way, making them straightforward for individual traders who want exposure to the index without any delivery complications.