What are Futures Contracts?

Definition
A futures contract is a standardized, exchange-traded agreement between two parties to buy or sell an underlying asset at a predetermined price on a specific date in the future. These contracts are used for speculation, hedging, and risk management across a variety of asset classes.

Understanding Futures Contracts

Futures contracts (commonly referred to as “futures”) are the building blocks of the futures market. Each contract outlines the specific terms for trading a particular asset in the future, including the asset type, contract size, tick size, expiration date, and delivery method.

Unlike stocks, which represent ownership in a company, futures are derivative instruments. Their value is derived from the price of an underlying asset, such as oil, gold, wheat, bitcoin, or the S&P 500 index. These contracts are traded on regulated exchanges and cleared through centralized clearinghouses to ensure contract integrity.

While the technical definition might sound complex, the use case is relatively straightforward: traders and businesses use futures either to speculate on price changes or to protect against them.

Key Characteristics of a Futures Contract

Every futures contract includes a set of specifications, known as contract specs, that define exactly how it trades. Here are some of the most important elements:

• Underlying asset: The commodity or financial instrument being traded (e.g., crude oil, gold, soybeans, bitcoin, stock indexes).

• Contract size: The standardized quantity of the asset per contract. For example:
• Crude oil = 1,000 barrels
• Gold = 100 troy ounces
• Micro E-mini S&P 500 = $5 x the index value

• Tick size: The smallest price increment a contract can move. For instance:
• E-mini S&P 500: 0.25 index points
• Gold futures: 0.10 per ounce

• Tick value: The monetary value of each tick. This is calculated as: contract size x tick size.
• Example: Gold = 100 ounces x 0.10 = $10 per tick.

• Trading hours: Most futures trade nearly 24 hours a day, Sunday through Friday, though each contract has specific hours.

• Expiration date: The final day the contract is tradable. After this date, the contract is settled either in cash or physical delivery.

Additional contract details include:

• Symbol codes
• Price limits and circuit breakers
• Delivery grade specifications
• Position limits
• Last trading day or first notice day

All these specs are standardized by the exchange that lists the contract, typically CME Group in the U.S.

Example: Gold Futures (/GC)

Gold futures are one of the most liquid and widely followed contracts in the metals market.

• Underlying asset: 100 troy ounces of gold
• Tick size: $0.10 per ounce
• Tick value: $10 per contract (100 ounces x $0.10)
• Settlement: Physical delivery
• Platform: CME Globex

Gold futures are used by jewelry manufacturers, institutional investors, and speculators to manage exposure to gold prices. These contracts are also popular among traders seeking to hedge against inflation or geopolitical uncertainty. While commercial participants may use them to secure future supply or revenue, retail traders often use gold futures to profit from price volatility without taking physical delivery of the metal.

How Traders Use Futures

Futures can be used for two main purposes: speculation and hedging.

Speculation

Traders speculate on the direction of an asset’s price. If they believe prices will rise, they go long (buy). If they expect a drop, they go short (sell).

Because futures require only a fraction of the total contract value as margin, traders can control large positions with relatively small capital. This leverage increases both potential profits and potential losses.

Hedging

Businesses and investors use futures to lock in prices and protect against market risk.

• A farmer might sell corn futures to guarantee a price before harvest.
• An airline might buy jet fuel futures to stabilize future fuel costs.
• A retail trader might use stock index futures to hedge a long equity portfolio during market volatility.

Even though retail traders are not classified as commercial hedgers, they can still use futures to offset portfolio risk.

Types of Futures Contracts

Futures exist across nearly every asset class:

Commodities:

• Agricultural: corn, wheat, soybeans, coffee
• Energy: crude oil, natural gas, gasoline
• Metals: gold, silver, copper, platinum

Financials:

• Stock indexes: S&P 500, Nasdaq-100, Dow Jones, Russell 2000
• Interest rates: Treasury bonds, Eurodollars, SOFR
• Currencies: EUR/USD, JPY/USD, GBP/USD

Digital assets:

• Cryptocurrencies: Bitcoin, Ether (CME-listed crypto futures)

Each contract has its own pricing mechanism, risk profile, and trading behavior.

Who Sets the Contract Specs?

Futures contracts are created and standardized by regulated exchanges, primarily the CME Group in the U.S. These exchanges act as the counterparty to both buyers and sellers. This eliminates counterparty risk and creates a transparent, anonymous trading environment.

The exchange also determines listing calendars, contract roll schedules, and settlement procedures. This structure ensures consistent trading behavior and easier analysis across contracts.

Futures vs. Stocks

Futures and stocks differ in several key ways:

• Ownership: Futures do not represent ownership; they are agreements to transact in the future. Stocks represent partial ownership of a company.

• Expiration: All futures contracts expire on a specific date. Stocks can be held indefinitely.

• Leverage: Futures are typically traded using margin, which allows traders to control large positions with less capital. Stocks can also be bought on margin, but usually with less leverage.

• Dividends: Futures do not pay dividends. Stocks may pay dividends to shareholders.

• Short Selling: With futures, going short is as easy as going long—no borrowing is required. In stock trading, short selling involves borrowing shares and may incur fees.

• Pattern Day Trading (PDT) Rules: Futures are not subject to PDT rules, which means traders are not limited in the number of day trades. Stocks in U.S. accounts are subject to these rules.

• Risk: Futures trading can lead to losses exceeding the initial investment due to leverage. With stocks, losses are generally limited to the amount invested.

Futures vs. Options

Here are some of the main differences between futures and options:

• Obligation: Futures require both the buyer and the seller to fulfill the contract at expiration. In options, the buyer has the right (but not the obligation) to exercise, while the seller has the obligation only if exercised.

• Premium: Futures do not require an upfront premium. Options buyers must pay a premium to enter the trade.

• Strike Price: Futures contracts do not have strike prices. Options revolve around a strike price that determines profitability.

• Leverage: Futures inherently use margin to achieve leverage. Options can be structured with or without leverage, depending on the strategy.

• Settlement: Futures are settled by physical delivery or cash depending on the contract. Options are typically settled in cash or exercised for the underlying asset.

• Complexity: Futures contracts tend to be simpler in structure. Options offer a wide variety of strategies and variables, making them more complex to trade.

Takeaway

Futures contracts are powerful, standardized agreements used to speculate, hedge, and manage risk across a broad range of asset classes. They offer flexibility, transparency, and liquidity, but they also carry leverage-driven risk.

Understanding the contract specifications, how margin works, and the mechanics of expiration is essential for any trader entering the futures market.

In the next lesson, we’ll explore what futures trading actually looks like for beginners: how trades are placed, why traders use leverage, and how profit and loss work in real time.

Next lesson: What is Futures Trading? A Beginner’s Guide →

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