What Is a Futures Contract?

What Is a Futures Contract?

A futures contract is a standardized, legally binding agreement between two parties to exchange an asset at a predetermined price on a specific future date. The asset could be a barrel of crude oil, a bushel of wheat, a government bond, or even a stock index — futures exist across virtually every major financial market. "Standardized" is the key word: the exchange that lists the contract decides the exact quantity, quality, and delivery terms, so every participant is working from an identical rulebook.

This standardization is what makes futures tradable. Because every contract for, say, West Texas Intermediate crude oil specifies exactly the same grade and volume, buyers and sellers can find each other quickly without negotiating the fine print each time. That ease of trading is a form of liquidity — you can enter or exit a position without getting stuck.

The Anatomy of a Contract

Every futures contract has a handful of defining terms worth knowing before anything else makes sense.

• Underlying asset: What the contract is actually about — crude oil, corn, gold, the S&P 500, and so on.
• Contract size: The fixed quantity covered by one contract. One standard crude oil futures contract covers 1,000 barrels. One standard corn contract covers 5,000 bushels. You can explore how these units work in detail in Barrels, Bushels and Troy Ounces.
• Delivery month: The month in which the contract expires and settlement occurs. Contracts are usually listed several months into the future simultaneously — for example, March, June, September, and December maturities might all be available at once.
• Tick size: The smallest permitted price move. If a crude oil contract has a tick size of one cent per barrel, and a contract covers 1,000 barrels, then one tick of movement equals $10 in profit or loss per contract.
• Settlement method: How the contract closes out. More on this below.

Physical vs Cash Settlement

When a futures contract expires, one of two things happens: physical delivery or cash settlement.

Physical delivery means the seller actually hands over the underlying asset and the buyer takes ownership. Most agricultural and energy futures were originally designed this way — a grain elevator delivers corn, a pipeline transfers oil. In practice, the vast majority of traders close their positions before expiry to avoid ever touching the physical commodity.

Cash settlement means no physical goods change hands. Instead, the two parties simply exchange the difference in cash between the agreed contract price and the market's final settlement price on expiry day. Most financial futures — index futures, interest-rate futures — settle this way, because there is no physical "S&P 500" to deliver.

The April 2020 reminder: In April 2020, the front-month WTI crude futures contract briefly traded at negative prices — meaning sellers were effectively paying buyers to take oil off their hands. This happened because storage tanks near the delivery point in Cushing, Oklahoma, were nearly full during pandemic lockdowns, and traders who had not closed their positions faced the prospect of physically receiving thousands of barrels of oil they had nowhere to put. It was a vivid demonstration that expiry mechanics are real: if you hold a physically settled contract to the wire, the underlying logistics matter.

Who Uses Futures and Why

Futures markets exist because of a genuine economic need: two very different groups of people want the same contract, for opposite reasons.

Hedgers

Hedging means using a futures contract to reduce price risk on something you already own or plan to buy. Consider a wheat farmer who plants in spring and harvests in autumn. Suppose the current price is $6 per bushel — a level the farmer finds profitable. Prices could fall to $4 by harvest time, wiping out the margin. By selling wheat futures at today's price, the farmer locks in roughly $6 regardless of what happens in the open market. The futures contract acts as insurance.

An airline faces the mirror-image problem: it needs to buy jet fuel constantly, and rising prices hurt profits. Airlines routinely buy fuel or crude oil futures to lock in purchase costs months in advance. If fuel prices rise, the futures gain in value and offset the higher cost at the pump. If prices fall, the airline pays more on the futures but benefits from cheaper physical fuel — the two largely cancel out. The goal is not to profit from the futures; it is to reduce uncertainty in the underlying business.

Speculators

Speculation is the other side of every hedge. A speculator has no physical commodity to protect — they simply form a view on where a price is heading and take a position. If they expect crude oil to rise, they buy futures; if they expect it to fall, they sell futures through a process called short selling, which futures markets make straightforward. Speculators provide the liquidity that lets hedgers get in and out quickly. Without them, a farmer trying to sell wheat futures might struggle to find a buyer.

Margin and Leverage: The Double-Edged Sword

Margin in futures markets is not a loan in the traditional sense — it is a good-faith deposit that proves you can cover potential losses. When you open a futures position, the exchange requires you to post an initial margin, typically a small fraction of the contract's total value. Suppose a crude oil contract covers 1,000 barrels priced at $80 each (hypothetical example) — the total notional value is $80,000. The initial margin required might be only a few thousand dollars.

That gap between margin posted and notional value controlled is leverage. Leverage amplifies both gains and losses proportionally. If the price moves in your favor by 5%, a leveraged futures position can return many times 5% on the capital you actually put up. If it moves against you, losses scale just as fast, and if your account falls below a threshold called the maintenance margin, you receive a margin call — a demand to top up your account or have your position liquidated automatically.

Traders also watch open interest — the total number of outstanding contracts that have not yet been closed — as a measure of how much capital is committed to a market at any moment.

Expiry and Rolling to the Next Contract

Every futures contract has an expiry date, after which trading in that specific contract stops and settlement occurs. The contract closest to expiry is called the front month and is usually the most actively traded. As the front month approaches its last trading day, participants who want to maintain exposure without taking delivery must "roll" their position — they close the expiring contract and open an equivalent position in the next month's contract.

Rolling sounds mechanical, but it has a cost or benefit depending on the shape of the futures curve. When contracts further out in time are priced higher than the front month — a condition called contango — rolling means selling cheap and buying expensive, which creates a drag. When the curve slopes the other way — called backwardation — rolling works in the holder's favor. The Contango and Backwardation guide covers these dynamics in full, and Spot vs Futures Prices explains why the two prices differ in the first place.

The roll yield — the gain or loss generated purely from this monthly rolling process — can significantly affect the real-world return of anyone holding futures positions over a long period.

Futures Across Asset Classes

Futures are not limited to commodities. They trade across a wide range of assets.

Because futures span so many asset classes, they show up throughout market data. Equity index futures, for instance, trade around the clock and are closely watched before regular stock-market hours as a signal of where stocks might open. Currency futures supplement the forex market. And commodity futures are the primary price-discovery mechanism for everything from oil to orange juice — the prices you see quoted on a commodities page are almost always the front-month futures price, not a spot transaction.

Understanding futures mechanics — the contract size, the expiry, the margin requirements — is foundational to reading almost any piece of market data. The How Market Quotes Work guide explains how these prices are displayed and what the numbers beside them mean.