What a futures contract is

A futures contract is an agreement to buy or sell a specific asset at a set price on a set date in the future. You do not own the asset yet. Instead, you are locking in a price now for something that will change hands later — often months away. The contract itself is what you trade, not the underlying commodity or financial instrument.

Futures exist for physical goods like wheat, crude oil, and gold, and for financial instruments like stock market indexes, Treasury bonds, and foreign currencies. The exchange where you trade futures — the Chicago Mercantile Exchange (CME) is the largest in the United States — sets the contract size, expiration date, and price movements allowed each day. You buy and sell these standardized contracts through a broker.

The price of a futures contract moves up and down based on what traders think the asset will be worth at expiration. If you buy a crude oil futures contract at $75 per barrel and the price rises to $80, your contract gains value. If it falls to $70, your contract loses value. You can close out your position — sell what you bought or buy back what you sold — at any time before expiration, locking in your gain or loss.

Key Takeaways

  • A futures contract locks in a price for an asset you will buy or sell on a specific future date, and you trade the contract itself rather than taking ownership of the asset.
  • Futures contracts are standardized by the exchange, meaning the size, expiration date, and price tick are the same for every trader in that contract.
  • You can close a futures position before expiration by taking the opposite trade, so you do not have to wait until the contract expires or take physical delivery.
  • Futures use leverage, meaning you control a large contract value with a small amount of money upfront, which magnifies both gains and losses.
  • Futures prices move continuously during trading hours, and daily losses can force you to add money to your account or have your position closed by your broker.

How leverage works in futures trading

When you trade futures, you do not pay the full contract value upfront. Instead, you put down a margin — a fraction of the total contract value — and your broker lends you the rest. This is leverage. A crude oil futures contract represents 1,000 barrels. At $75 per barrel, that is $75,000 in value. Your broker might require only $5,000 in margin, giving you control of a $75,000 position with $5,000 of your own money.

Leverage amplifies both gains and losses. If the price moves $1 per barrel in your favor, your $5,000 margin grows by $1,000 — a 20 percent gain. If the price moves $1 per barrel against you, your margin shrinks by $1,000. A $5 move against you wipes out your entire $5,000 margin. This is why futures trading carries substantial risk.

Your broker tracks your account balance daily. If losses eat into your margin below a minimum level — called the maintenance margin — your broker will issue a margin call, requiring you to deposit more money within a set time, usually by the end of the trading day. If you do not deposit funds, your broker can close your position automatically to protect themselves from further losses.

The difference between hedging and speculation

Traders use futures for two distinct purposes. A hedger uses futures to lock in a price and reduce risk. A wheat farmer might sell wheat futures contracts in spring to lock in a price for the harvest in fall, protecting against a price drop. An airline might buy crude oil futures to lock in fuel costs months ahead, protecting against a price spike. The hedger is not trying to profit from price swings — they are trying to eliminate uncertainty.

A speculator trades futures to profit from price movements. They have no intention of taking physical delivery of wheat or oil. They buy a contract expecting the price to rise, or sell a contract expecting the price to fall. If they are right, they close the position and pocket the difference. If they are wrong, they take a loss. Speculators provide liquidity to the market — they make it straightforward for hedgers to buy and sell contracts — but they also accept the full risk of price swings.

Most futures traders are speculators. The leverage available in futures makes them attractive to traders seeking large returns on small capital, but it also makes losses large and fast.

How futures prices are set and move

Futures prices are set by supply and demand on the exchange floor and on electronic trading platforms. Thousands of traders place buy and sell orders simultaneously. The price at any moment is straightforward the last price at which a trade occurred. As new information arrives — a weather report affecting crop yields, an economic data release, geopolitical events — traders adjust their bids and offers, and the price shifts.

Futures contracts have daily price limits set by the exchange. If a contract moves too far in one direction in a single day, trading halts temporarily. For example, crude oil futures might have a daily limit of $10 per barrel. If the price tries to move more than $10 from the previous close, trading stops for a period. This rule exists to prevent panic selling or buying from cascading into a crash.

Futures prices also reflect the time until expiration. A contract expiring in one month will trade at a different price than a contract expiring in six months, even though both are for the same underlying asset. As expiration approaches, the futures price converges toward the spot price — the current market price of the asset itself. On the expiration date, the futures price and spot price are essentially the same.

What happens when a futures contract expires

When a futures contract reaches its expiration date, the contract ceases to exist. At that point, one of two things happens: physical delivery or cash settlement. Most financial futures — those based on indexes or bonds — are settled in cash. The exchange calculates the difference between your contract price and the final settlement price, and credits or debits your account. You never take ownership of the underlying asset.

Commodity futures like crude oil or wheat can be settled by physical delivery, though this is rare for individual traders. If you hold a crude oil contract at expiration and do not close it, you are obligated to take delivery of 1,000 barrels of oil. Most traders close their positions well before expiration to avoid this outcome. Brokers will typically warn you as expiration approaches and may close your position automatically if you do not act.

Traders who want to maintain exposure to an asset past one contract's expiration can roll their position — close the expiring contract and open a new one with a later expiration date. This keeps the position open but shifts it to a new contract month.

The costs and risks of futures trading

Futures trading involves several costs beyond the price movement itself. Your broker charges a commission for each trade — typically a flat fee per contract or a small percentage of the contract value. These fees add up quickly if you trade frequently. Some brokers also charge inactivity fees if your account sits idle.

The primary risk is leverage. Because you control a large position with a small margin, a small adverse price move can wipe out your entire investment and leave you owing money to your broker. Margin calls can force you to add funds quickly or lose your position. Futures markets are also highly liquid and move fast, so prices can gap — jump suddenly — leaving you unable to close a losing position at the price you expected.

Futures trading also requires active monitoring. Prices move continuously during market hours, and you need to watch your position or set automatic stop-loss orders to limit losses. Unlike stocks, where you can hold for years, futures contracts expire, forcing you to make a decision about rolling or closing before that date arrives.

Frequently Asked Questions

Can I lose more money than I put in with futures?

Yes. If your position moves sharply against you and you do not close it, losses can exceed your initial margin. Your broker can issue a margin call requiring you to deposit additional funds. If you do not meet the call, your broker closes your position, but you may still owe money if losses exceed your account balance.

Do I have to take physical delivery of the commodity?

No, not if you close your position before expiration. Most individual traders close their contracts days or weeks before expiration. If you hold a commodity futures contract until expiration without closing it, you may be obligated to take delivery, which is why brokers typically force closure or require you to roll to a later contract month.

What is the difference between futures and options?

A futures contract is an obligation to buy or sell at a set price on a set date. An options contract gives you the right, but not the obligation, to buy or sell. With futures, you must follow through or close the position. With options, you can let the contract expire worthless if it is not profitable. Options typically require less margin but have different pricing mechanics.

How much money do I need to start trading futures?

Margin requirements vary by contract and broker, but typically range from $1,000 to $10,000 per contract. Some brokers set account minimums of $2,000 to $5,000. However, having the minimum margin is not the same as having enough money to trade safely — losses can consume your margin quickly, and you need additional funds to cover margin calls.

Are futures traded only during market hours?

Most futures trade during official exchange hours, but many contracts also trade in an after-hours session. Crude oil and stock index futures, for example, trade nearly 24 hours a day on electronic platforms. Liquidity is typically lower outside official hours, meaning wider bid-ask spreads and potentially larger price gaps.