Futures

Futures and forward contracts are agreements for future delivery of commodities or other assets. Unlike options, both parties are obligated to perform. This section covers the structure, margin mechanics, and key distinctions between futures and forwards.

Futures Contracts

A futures contract is a standardized, exchange-traded obligation to buy or sell an asset at a predetermined price on a future date.

Key characteristics:

• Standardized: The exchange specifies contract size, delivery months, last trading day, and delivery specs; nothing is negotiable
• Exchange-traded: Traded on regulated exchanges (e.g., CME Group); highly liquid
• Obligation, not a right: Both buyer and seller are obligated to perform (unlike options, where only the seller is obligated)
• Clearinghouse: Interposes between buyer and seller after trade match, eliminating counterparty risk
• High leverage: Small margin deposit controls a large contract value
• Settlement: Most contracts are offset (closed out) before delivery; few result in physical delivery
• Regulated by the CFTC: Futures are not securities and are regulated by the Commodity Futures Trading Commission (CFTC), not the Securities and Exchange Commission (SEC)

Common underlying assets:

• Commodities: agricultural (corn, wheat, soybeans), energy (crude oil, natural gas), metals (gold, silver)
• Financial: stock indexes (S&P 500), interest rates (Treasury bonds), currencies (euro, yen)

Think of it this way: With options, only the buyer can decide whether to exercise. The seller might never have to do anything if the option expires worthless. But with futures, both parties have signed a binding contract. When expiration comes, the buyer must buy and the seller must sell. No one gets to walk away.

Exam Tip: Gotchas

• Both buyers and sellers of futures have obligations. Option buyers have rights, not obligations. This is the key distinction between options and futures/forwards.

Futures Margin

Futures margin works differently from stock margin. It is a performance bond, not a loan.

• Initial margin: Deposit required to open a position; posted by both buyer and seller
• Maintenance margin: Minimum account balance that must be maintained
• Margin call: If account falls below maintenance margin, additional funds are required
• Mark-to-market: Accounts are settled daily; gains and losses are credited/debited each trading day

Exam Tip: Gotchas

• Futures margin is a good-faith performance deposit, not a loan. No interest is charged on futures margin. Unlike stock margin (which is a loan from a broker), futures margin is simply a deposit posted by both parties.

Forward Contracts

A forward contract is a private, customized over-the-counter (OTC) agreement to buy or sell an asset at a specified price on a specified future date.

Key characteristics:

• OTC (not exchange-traded): Privately negotiated between two parties
• Fully customizable: Contract size, delivery date, location, and asset quality are all negotiable
• No daily settlement: No mark-to-market; contract settles only at maturity
• No margin requirement: No performance bond; parties may negotiate collateral privately
• Counterparty risk: No clearinghouse means each party bears the risk that the other defaults
• Illiquid: No secondary market; difficult to exit before maturity
• Largely unregulated: Not subject to CFTC exchange rules

Think of it this way: A forward contract is like a handshake deal between two people. You agree on terms privately, and everything is flexible. But if the other person walks away on delivery day, you have no clearinghouse to step in and make good on the deal. That counterparty risk is the trade-off for all that flexibility.

Futures vs. Forwards

This comparison is frequently tested.

Exam Tip: Gotchas

• Futures eliminate counterparty risk; forwards do not. The clearinghouse is the key difference.
• Forwards are OTC and customizable; futures are standardized and exchange-traded. If the exam describes a "customized, privately negotiated agreement," it is a forward.