Futures Contract
What is Futures Contract?
A futures contract is an agreement to buy or sell an asset at a set price on a specific future date.
Farmers and airlines use futures to lock in prices and hedge against swings in commodities like grain or oil. Speculators trade them to profit from price changes. They are standardized and traded on exchanges.
Futures Contract: a worked example
Hollis Farms expects 10,000 bushels of corn at harvest, and the December future is quoted at $5.20 a bushel. Hollis sells futures covering 10,000 bushels, locking in $52,000. By harvest the spot price has dropped to $4.60, so the crop sells locally for $46,000, but the short futures position gained $0.60 a bushel, or $6,000, leaving $52,000. Had the spot price instead risen to $5.90, the crop would fetch $59,000 while the futures position lost $0.70 a bushel, or $7,000, again leaving $52,000. The hedge removed the upside along with the downside.
The mistake students make with futures contract
A hedge gets judged by the futures leg alone, so the farmer whose futures position lost $7,000 looks like a bad trader. That leg was doing its job, because the crop sold for exactly that much more. The second error is expecting a truck of grain to show up. Most positions are closed by taking the opposite contract before expiry and settled in cash. Futures feel like a bet because they can be used as one, but for a hedger the contract and the physical crop are a single position, not two.
Futures Contract questions
What is the difference between a futures contract and an options contract?
A futures contract obligates both sides to trade at the agreed price, while an options contract gives its holder the right to walk away. If oil falls, a futures buyer still has to pay the higher agreed price; an option buyer simply lets the option expire and loses only the premium already paid. That escape route is why options cost money upfront and futures do not.
Do you have to actually deliver the goods in a futures contract?
Futures contracts rarely end in physical delivery, because most traders close out by taking the offsetting contract before the delivery window. A seller buys back an identical contract, the two cancel, and only the cash difference changes hands. Delivery terms still matter, since the possibility of delivery is what keeps the futures price tied to the actual commodity near expiry, but for most contracts nothing is ever loaded onto a truck.
What is margin in futures trading?
Margin in futures trading is a good-faith deposit posted with the exchange by both sides, not a down payment on the goods. A position covering $52,000 of corn might require only a few thousand dollars of margin, and the exchange credits or debits that account every day as prices move. If the balance falls below the maintenance level, the trader must add cash or the position is closed out. That daily settlement is why futures losses arrive long before expiry.
Related terms
Common comparisons
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