Futures
Now that you understand options (where the buyer has a right but not an obligation), the next step is futures contracts, where both parties are obligated to perform.
What Is a Futures Contract?
A futures contract is a legally binding agreement to buy or sell a specified asset at a predetermined price on a future date.
Key characteristics:
- Both parties are obligated: unlike options, where only the seller is obligated, a futures contract requires both the buyer and the seller to fulfill the terms
- Standardized contracts: the exchange sets the contract size, delivery date, quality specifications, and other terms
- Exchange-traded: futures trade on regulated exchanges like the CME Group (Chicago Mercantile Exchange)
- Clearinghouse-backed: the exchange clearinghouse acts as the counterparty to both sides, virtually eliminating counterparty risk
Exam Tip: Gotchas
- Options vs. futures obligation: In options, only the seller is obligated. In futures, both buyer and seller are obligated. This distinction is tested often.
What Futures Cover
Futures contracts are available for a wide range of underlying assets:
| Category | Examples |
|---|---|
| Commodities | Oil, natural gas, wheat, corn, gold, silver |
| Financial instruments | Treasury bonds, Treasury notes, Eurodollars |
| Stock indexes | S&P 500, Nasdaq 100, Dow Jones |
| Currencies | Euro, Japanese yen, British pound |
Margin and Daily Settlement
Two features distinguish futures from other contracts:
Margin
- Both the buyer and seller must post margin, a good-faith deposit (not a loan like stock margin)
- If the position moves against an investor, a margin call requires them to deposit additional funds
- Failure to meet a margin call can result in the position being liquidated
Mark-to-Market (Daily Settlement)
- Gains and losses are calculated and settled every trading day
- If a futures contract moves in your favor, the gain is credited to your account that day
- If it moves against you, the loss is debited from your account that day
- This daily process prevents large losses from accumulating unnoticed
Exam Tip: Gotchas
- Futures margin is not a loan; it is a performance deposit, unlike margin in a stock brokerage account where you are borrowing money
- Mark-to-market means daily settlement; futures do not wait until expiration to settle gains and losses