Derivatives · Intermediate · 4 min

How futures work

You can explain what a futures contract obliges both sides to do, how gains and losses are calculated and why most futures never lead to delivery.

A binding promise

An option gives its buyer a choice. A futures contract does not. Both sides promise to trade a set amount at a set price on a set date, and both are held to it until they close the position.

Futures were created for farmers and merchants, as the lesson on derivatives explained. Today they cover indices, interest rates, currencies and commodities, and they are one of the main ways professionals trade. This lesson explains how they work.

Standard, margined, daily

A futures contract is standardized by the exchange. Each contract defines:

the underlying, such as a stock index, a bond or a barrel of a specific oil grade,
the size of the contract, often through a contract multiplier that turns price points into money,
the expiry months and how the contract is settled.

How a position works, as the CFTC describes it:

Both buyer and seller post initial margin with their broker, as a performance bond.
Every day, the position is marked to market. Gains are credited, losses debited. The next lesson covers this in detail.
The position ends when it is closed with an opposite trade, rolled into a later contract or held to expiry.

At expiry, some futures lead to physical delivery, for example of commodities. Many financial futures use cash settlement: instead of delivery, the difference between the contract price and the final settlement price is paid. The CFTC notes that most futures positions are closed before expiry anyway.

A futures position has no premium to lose and no built-in floor. Gains and losses grow with every point the price moves, and losses can exceed the margin posted.

40 points × 50 = 2,000

A fictional trader buys one E-mini S&P 500 future at 5,000 points. CME sets the multiplier at 50 dollars per point.

Notional value: 5,000 × 50 = 250,000 dollars.
The index rises 40 points to 5,040. Gain: 40 × 50 = 2,000 dollars.
Had it fallen 40 points, the loss would have been 2,000 dollars.

The trader posted only a fraction of 250,000 as margin, so a move of less than 1% in the index changed the account by thousands of dollars.

Common mistakes

Ignoring the multiplier. It decides how much each point is worth.
Treating margin as the maximum loss. Losses can exceed it.
Forgetting expiry. Positions must be closed or rolled in time.
Holding physically settled contracts into delivery. Brokers usually close them, often at a cost.

The takeaway

A future binds both sides to trade at a set price on a set date. Gains and losses equal the price change times the contract size, settled daily.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the step in which gains and losses are paid every day.

Tap the chart.

Futures are marked to market daily: gains are credited and losses debited from the margin account.
2You buy one E-mini S&P 500 future, with a multiplier of 50, at 5,000. It rises to 5,040. What is your gain?

40 points × 50 = 2,000. The multiplier turns index points into money.
3Do most futures traders receive the physical commodity?

The CFTC notes that most futures are offset before expiry. Index futures settle in cash.
4What is the difference between a future and an option?

With a future, both gains and losses are open for both sides, until the position is closed.

of 4 correct.