Introduction to Trading Futures Contracts Bookmark and Share

What is a Futures Contract?

By definition, a futures contract is a legally binding agreement to buy or sell a commodity or financial instrument in a designated future month at a price agreed upon today by the buyer and seller. Futures contracts are standardized according to the quality, quantity, and delivery time and location for each commodity, and are traded on regulated exchanges. A future is part of a class of securities called derivatives. A derivative is a security that derives its value from the value of an underlying instrument. More specifically, a future is classified as an exchange traded derivative because the exchange's clearinghouse acts as counterparty on all trades, sets margin requirements, and provides the mechanism for settlement.

What Products can I Trade Using Futures Contracts?

Futures contracts allow an investor to trade a variety of underlying instruments, varying from single stocks to real estate prices.

  • Commodities

    • Grains and Oilseeds, Livestock, Dairy, Forest, Softs, Energy, Metals, Commodity Indices, ...

  • Equity Index

    • US Indices, International Indices, ETF Futures, ...

  • FOREX

    • G10 Currency Pairs, Emerging Market Currency Pairs, ...

  • Interest Rates

    • Eurodollar & Fed Funds Futures, US Treasury Futures and Options, Swap Futures and Options, Treasury and Swap Spreads, Interest Rate Index Futures, ...

  • Real Estate

    • S&P/Case Shiller Home Price Indices, ...

  • Weather

    • Temperature, Hurricanes, Frost, Snowfall, ...

  • Credit

    • Single Stock Futures, Credit Default Swap Contracts

For a more detailed list of futures contracts, please visit cmegroup.com.

Advantages of Trading Futures Contracts

The number one reason futures contracts have been used to trade financial instruments other than commodities is leverage, or the ability to profit handsomely from small movements in the price of the underlying. Futures positions are highly leveraged because the initial margins that are set by the exchanges are relatively small compared to the cash value of the contracts in question. The smaller the margin in relation to the cash value of the futures contract, the higher the leverage. For example, for an initial margin of $2,000, you might be able to control $20,000 of a particular commodity. Because of leverage, futures trading is extremely risky and is not for the faint of heart.

Margin Requirements

To protect against default by an investor on his or her futures contract, exchanges require investors to post a margin or performance bond that is a small portion of the contract's value. The contracts are margined on a daily basis based on the closing prices of the contracts. The amount margin required is directly proportional to the price volatility of the futures contract. The most commonly mentioned margins in futures trading are the initial margin and the maintenance margin.

  • Initial Margin

    • The initial margin is the amount of money needed to take a position in a futures contract. It functions as a security deposit to ensure that an individual will have sufficient funds to meet any potential loss from a trade. If the price of the contract moves against the individual and erodes the initial margin, the futures broker will make a "margin call" when the amount of margin falls below the pre-established amount of maintenance margin. Futures accounts are marked to market daily and calls for margin are usually expected to be paid and received on the same day. Failure to meet margin calls results in your account being closed.

  • Maintenance Margin

    • A set minimum margin per outstanding futures contract that a individual must maintain in his margin account.

Futures Prices and Limits

Prices on futures contracts have a minimum amount they can move which is known as a "tick". The "tick" amounts are set by the exchanges and may be revised based on trading conditions. For example the tick value on a crude oil contract is one cent whereas the tick value on eurodollar futures is one-quarter of a basis point.

Futures contracts also have a limit on price changes after which trading is halted. When prices move higher and touch the upper limit, the contract is said to be "limit up", and when prices touch the lower limit, the contract is said to be "limit down". Normally when a contract trades "limit up" or "limit down" trading is halted for the day, but there are exceptions, as with crude oil, which won't hit its limit until it moves $10 in a day. When the price of crude oil moves $10, trading is halted for 5 minutes, an additional $10 is added to the limit, and trading resumes.

Furthermore, in order to avoid any unfair advantages, futures exchanges impose limits on the total amount of contracts or units of a commodity in which any single person can invest. These are known as position limits and they attempt to ensure that no one person can control the market price for a particular commodity.

Futures Contract Expiry and Settlement

Expiry is is the time and day that a particular delivery month of a futures contract stops trading and the final settlement price for that contract month and year is calculated. Settlement is the act of fulfilling your contractual obligations and can be done one of two ways:

  • Physical Settlement

    • In physical settlement the amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. Physical delivery is common with commodities and treasury futures. In practice, however, it occurs very infrequently because futures market participants usually reverse or close out their positions prior to expiry. Every once in a while, you hear about the commodities trader who is now stuck with a freight car full of corn he or she didn't want because they forgot to close their position.

  • Cash Settlement

    • In cash settlement a cash payment is made based on an underlying reference rate. The reference rate could be an interest rate index such as LIBOR or the closing value of a stock market index like the S&P 500.

Futures Exchanges

The exchanges responsible for the majority of futures trades are:


Note: Due to recent consolidation in the industry the CBOT, CME, and NYMEX are all part of the CME Group. Also, the NYBOT is now a wholly owned subsidiary of ICE.
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