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What is a futures contract, and how does it differ from buying the commodity itself? A futures contract is an agreement to buy or sell a set amount of a commodity at a price agreed today, for delivery on a future date. This guide covers how a futures contract works, who uses it, how to read a quote, how positions end, and the risks to understand before you go near one.
The basic idea
The CFTC, the U.S. futures regulator, explains that in a commodity futures contract the price and amount are fixed when the agreement is made. The buyer agrees to take the commodity later; the seller agrees to deliver it.
Picture a wheat farmer in spring who worries prices will fall by harvest. She can sell wheat futures now, locking in a price. A flour mill worried about rising prices can buy futures, locking in its cost. Each side aims to reduce price uncertainty, although local cash prices and futures can move differently. Neither needs to know who the other is, because the exchange and its clearinghouse sit in the middle.
What makes a futures contract different
Futures are standardized and traded on exchanges. The SEC’s investor site notes that exchange-traded futures have a set unit size, a fixed expiration date and centralized clearing.
| Feature | What it means |
|---|---|
| Standardized size | Each listed product has its own fixed quantity; different products covering the same commodity can have different sizes |
| Set quality | The exchange defines the grade that can be delivered |
| Fixed expiry | Each contract has a delivery month and a last trading day |
| Central clearing | A clearinghouse stands between buyer and seller and guarantees the trade |
| Price is the only variable | Everything else is fixed, so traders only negotiate price |
Central clearing matters. Because the clearinghouse is the counterparty to every trade, you don’t need to trust the person on the other side. It also means every open position is marked to the market price each day, with gains and losses settled through your account rather than waiting until expiry.
How to read a futures quote
A futures quote looks confusing at first because one commodity has many prices, one for each delivery month. A few terms unlock it:
- Contract month. The month the contract expires or delivers. December gold and February gold are different contracts with different prices.
- Front month. The nearest contract still trading. This is usually the price quoted in the news.
- Settlement price. The official end-of-day price the exchange uses to calculate daily gains and losses.
- Tick size. The smallest allowed price move, and the dollar value of that move for one contract.
- Open interest. The number of contracts currently open. It shows how active a given month is.
Before trading any contract, read the exchange’s contract specifications page. It tells you the size, tick value, trading hours, last trading day and whether the contract settles physically or in cash.
Who uses futures contracts
- Hedgers are businesses that produce or use the commodity: farmers, miners, airlines, food companies, refiners. They use futures to manage price risk.
- Speculators are traders who have no need for the physical commodity. They aim to profit from price moves and, in doing so, take on the risk hedgers want to shed.
The CFTC notes that most futures market participants are commercial or institutional producers and users of commodities. Speculators matter too, because they add liquidity: a hedger can only lock in a price if someone is willing to take the other side.
Long and short
Buying a futures contract is called going long. You benefit if the price rises. Selling one is going short. You benefit if the price falls. A short futures position uses the contract rather than borrowing shares. Both long and short positions require margin and are subject to trading fees and settlement obligations.
Margin: how a futures contract is paid for
You don’t pay the full value of a futures contract upfront. You post margin, a deposit that’s a fraction of the contract’s value. Two margin terms matter:
- Initial margin is the deposit needed to open a position. The exchange sets a minimum and your broker may require more.
- Maintenance margin is the minimum balance you must keep while the position is open. If losses push your account below it, you get a margin call and must add funds or close the position.
Here is a simplified, hypothetical example. Suppose a contract covers 1,000 barrels of oil and the price is $70, so the contract is worth $70,000. If the exchange requires a $7,000 deposit, a $1 move in the oil price changes your position by $1,000, which is about 14% of your deposit. A $7 move against you, in this hypothetical scenario, wipes out the whole deposit. That is leverage, and it cuts both ways.
Leverage: the part to respect
Leverage means a small price change produces a large gain or loss relative to your deposit. CME Group warns that with futures it’s possible to lose more than you deposited. Unlike buying a stock outright, where your loss is capped at what you paid, a futures loss can exceed your account balance, and you owe the difference.
The CFTC describes speculating in futures and options as volatile, complex and risky, and rarely suitable for individual retail investors. If you’re exploring commodities for the first time, compare the structures and risks of other ways to get exposure, including products that hold physical assets or futures. Our guide to crude oil trading basics shows how one market works in practice.
How a futures contract position ends
There are three ways a position can end.
- Offset. You take the opposite trade before expiry. If you bought one contract, you sell one of the same contract to close it. This is how most speculators exit.
- Physical delivery. If you hold to expiry on a physically settled contract, the commodity actually changes hands under the exchange’s rules.
- Cash settlement. Some contracts settle in cash against a reference price instead of delivering anything.
Retail traders almost never want physical delivery. Brokers usually require you to close positions well before delivery begins, and may close them for you. Write the first notice day and last trading day in your calendar when you open a position so neither arrives as a surprise.
Rolling a position and why months differ in price
A trader who wants to stay in a market past expiry “rolls”: they close the expiring contract and open the next month. Because the two months rarely trade at the same price, rolling has a cost or a benefit.
- When later months are more expensive than nearer ones, the market is in contango. Rolling a long position means selling low and buying high, which drags on returns over time.
- When later months are cheaper, the market is in backwardation. This shape can contribute positive roll yield for a long position, but does not guarantee a profitable investment.
This is why a futures-based commodity fund can lag the spot price you see in the headlines. If you plan to hold for months, the shape of the futures curve matters as much as the direction of the price.
Futures contract vs. forward contract
A forward contract is a private, customized agreement between two parties, usually not traded on an exchange. Futures are the standardized, exchange-traded version. Forwards can be tailored but carry the risk that the other party fails to pay. Futures use central clearing to manage counterparty risk. Exiting still depends on market access and available buyers or sellers; clearing does not eliminate every credit or operational risk. Exiting or changing a forward depends on its agreement.
Common beginner mistakes
- Treating margin as the price. The deposit is not what you are risking. You are exposed to the full contract value.
- Not knowing the tick value. Work out what a one-point move is worth in dollars before you place the order.
- Holding into the delivery period. Know the last trading day and your broker’s cut-off.
- Trading the wrong month. A thinly traded back month can have wide spreads and sudden gaps.
- Ignoring overnight hours. Many futures trade almost around the clock, so a position can move a long way while you sleep.
- Skipping the risk disclosure. Read the risk disclosure documents supplied by your broker, as the CFTC recommends in its futures basics guide.
A checklist before your first futures contract
- Read the exchange’s contract specifications for size, tick value, hours and settlement type.
- Check the initial and maintenance margin, and decide the maximum loss you can accept in dollars.
- Note the first notice day and last trading day.
- Confirm your broker is registered. In the U.S., you can check a firm or individual through the National Futures Association.
- Practice with a simulated account until the mechanics are boring.
- Ask whether a non-leveraged product would meet your goal instead.
Frequently asked questions
Do I have to take delivery if I buy a futures contract?
Only if you hold a physically settled contract through expiry. Most traders close positions beforehand, and brokers typically require it.
Who regulates futures in the U.S.?
The Commodity Futures Trading Commission (CFTC) regulates U.S. futures markets, with the National Futures Association handling registration of firms and individuals.
Can I trade futures with a regular stock brokerage account?
You need a futures-enabled account, which some brokers offer separately and with extra approval steps.
The bottom line
So, what is a futures contract? It is a standardized, exchange-traded promise to buy or sell a commodity at a fixed price on a fixed date, centrally cleared and supported by a margin deposit rather than an upfront purchase of the full commodity value. That structure makes futures the reference price for most commodities and an efficient hedging tool for producers and users. It also makes them highly leveraged. Understand the contract specifications, the margin rules and the calendar before you trade one, and consider whether a simpler product fits your goal first.
Trading futures involves substantial risk of loss. Past performance does not guarantee future results. This article is for education only and is not financial advice.
