What Is A Futures Contract?

What Is A Futures Contract?

The commodities market attracts millions of traders every day. Traders buy and sell contracts on a variety of commodities, such as oil and gas, gold ,silver, agricultural products, livestock, etc. 

These contracts are called futures contracts and are some of the most popular investment vehicles on the market. 

However, futures contracts are not exclusive to commodities, as anything can be an underlying asset of a futures contract. 

Futures contracts are standardized financial agreements that obligate two parties to buy or sell an underlying asset, such as commodities, financial instruments, or stock indices, at a predetermined price on a specified future date.

These contracts are traded on futures exchanges and serve various purposes, including hedging and speculation.

They can be used to speculate on future price movements or to protect against price fluctuations. 

Futures are traded on major exchanges like Chicago Mercantile Exchange and traders can access them using their brokerage accounts. 

If you are a beginner trader and would like to know more about futures contracts and how they work, this Investfox guide is for you. 

How Futures Contracts Work

To understand how futures contracts work, let’s look at some key aspects traders need to consider before trading futures, such as:

  • Standardization: Futures contracts are standardized agreements, specifying the terms and conditions for the purchase or sale of an underlying asset. These terms include the asset's type, quantity, quality, price, and delivery date
  • Market Participants: Two parties are involved in a futures contract: the "long" position (buyer) and the "short" position (seller). Long position holders agree to buy the asset, while short position holders agree to sell it
  • Price and Margin: Futures contracts require an initial deposit known as the margin. This margin ensures that both parties can meet their contractual obligations. Daily price fluctuations result in gains or losses, affecting margin balances
  • Daily Settlement: Futures contracts are marked to market daily, meaning that at the end of each trading day, profits and losses are realized, and margin accounts are adjusted accordingly
  • Delivery or Offset: Most futures contracts are not physically delivered. Traders can offset their positions by taking an opposite position before the delivery date. This is known as offsetting or closing out the contract
  • Hedging and Speculation: Futures contracts serve both hedging and speculative purposes. Hedgers use them to protect against price risk, such as producers locking in prices for their products. Speculators aim to profit from price movements without intending to take delivery
  • Leverage: Futures contracts allow traders to control a large position with a relatively small initial investment (the margin). This leverage amplifies both potential profits and losses
  • Expiration: Each futures contract has an expiration date when the transaction must be settled. Traders must either offset their position or prepare for physical delivery, depending on the contract

Pros And Cons Of Trading Futures Contracts

Futures trading comes with certain advantages and disadvantages that traders need to consider to decide whether futures trading is the right choice for their financial objectives. 


  • Liquidity: Futures markets are highly liquid, allowing traders to enter and exit positions with ease, often with minimal bid-ask spreads
  • Risk Management: Futures contracts enable effective hedging against price fluctuations, helping businesses and investors manage price risk
  • Leverage: Futures allow traders to control a larger position with a relatively small margin, potentially amplifying profits
  • Diversification: Futures markets cover a wide range of asset classes, offering diversification opportunities for portfolio management


  • Leverage Risk: While leverage can amplify profits, it also magnifies losses, making futures trading highly risky
  • Volatility: Futures markets can be extremely volatile, leading to significant price fluctuations and potential losses
  • Initial Margin: Futures trading requires an initial margin, tying up capital and limiting flexibility in other investments
  • Complexity: Understanding the mechanics and risks of futures contracts can be challenging, especially for novice traders, and may require a steep learning curve

Key Takeaways From What Is A Futures Contract

  • Futures contracts are financial instruments that obligate two parties to buy or sell an underlying asset at a predetermined price on a specified future date
  • Futures are traded on major exchanges, such as the Chicago Mercantile Exchange
  • Traders can buy and sell futures contracts using their brokerage accounts, while having the opportunity to increase buying power through leverage
  • The futures market is characterized by high volatility, which gives traders many opportunities but also comes with a degree of risk

FAQs On Futures Contracts

How do futures contracts work?

Futures contracts are standardized agreements to buy or sell an underlying asset at a predetermined price on a specified future date. Traders take long (buy) or short (sell) positions, with daily mark-to-market adjustments based on price changes, and can either offset their positions or prepare for physical delivery at contract expiration.

Where can I trade futures contracts?

Futures contracts are traded on major exchanges, such as the Chicago Mercantile Exchange and traders can buy and sell them through their brokerage accounts. 

What is the underlying asset of a futures contract?

The underlying asset of a futures contract can vary widely and includes commodities (such as oil, gold, and wheat), financial instruments (like stock indices and interest rates), foreign exchange rates, and more. The specific asset is determined by the terms of the futures contract and its market.