Futures Contracts Explainer
A futures contract is a standardized agreement traded on an exchange to buy or sell a specified quantity and quality of an underlying interest at a future time. Many contracts are closed before delivery, and some settle in cash rather than transferring the underlying asset.
Exchanges specify the contract unit, delivery months, grades or reference calculations, price increments, hours, and final settlement. A clearinghouse becomes the central counterparty, reducing direct credit exposure between the original buyer and seller but not eliminating market risk.
Traders post performance-bond margin rather than paying the full notional value. Positions are marked to market, so gains and losses flow through accounts as prices change. The resulting leverage can make relatively small price moves produce substantial cash demands.
Producers and users may hedge input or selling prices, while speculators accept price risk in search of return. Hedging is rarely perfect: timing, quantity, location, quality, contract choice, liquidity, and the difference between spot and futures prices can all create basis risk.
The exchange defines size, quality, dates, and settlement.
Clearing stands between buyers and sellers.
It supports obligations rather than serving as a stock down payment.
Daily losses can require additional cash.
The contract may not exactly match the exposure.
Basis, timing, and quantity differences matter.
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