Introduction

Futures are one of the most important and widely used derivatives in financial markets. Whether you're a hedger protecting against price moves, a speculator seeking directional exposure, or an investor interested in commodity or index exposure, futures contracts provide a standardized, liquid mechanism to trade future delivery of an asset.

This post gives a practical, non-technical introduction to futures: what a futures contract is, essential terms to know, a simple example, common use cases, and the main risks.

What is a futures contract?

A futures contract is an agreement to buy or sell an asset at a predetermined price on a specified future date. Contracts are standardized (size, expiration, delivery specifications) and traded on regulated exchanges (for example, CME, ICE).

Key characteristics:

Standardized terms (contract size, tick value, expiration dates)
Traded on exchanges with a clearinghouse that guarantees performance
Margin-based: traders post and maintain margin rather than paying the full notional price up front
Settled either by physical delivery (less common for many traders) or cash settlement

Important terms

Notional / Contract Size: the quantity of the underlying represented by one contract (e.g., 100 barrels, 50 An index multiplier)
Tick and Tick Value: the minimum price increment and its monetary value per contract
Expiration / Delivery Date: when the contract settles or is rolled
Initial Margin / Maintenance Margin: collateral required to open and maintain a position
Mark to Market: daily settlement of gains and losses, with margin calls if the balance falls below maintenance
Long vs Short: long commits to buy the underlying in the future (benefits from price rises); short commits to sell in the future (benefits from price falls)

A simple example

Imagine a wheat farmer worried about prices falling before harvest. The farmer can sell (go short) wheat futures today at a fixed price. If spot prices fall before harvest, the loss in the cash market is offset by gains in the futures position. Conversely, a bakery expecting to buy wheat can go long futures to lock in future input costs.

Example numbers (simplified):

Current futures price for December wheat: $700 per contract (represents 100 bushels)
Farmer sells 10 contracts (lock in $700 _ 100 _ 10)
If price falls to $650 at harvest, the farmer's futures position gains$ 50 per bushel (offsetting lower spot revenue)

Common uses

Hedging: producers and consumers manage price risk (agriculture, energy, metals)
Speculation: traders attempt to profit from directional moves using leverage
Arbitrage and basis trading: exploit price differences between spot and futures or between expirations
Exposure and portfolio management: investors gain or reduce exposure to commodity or index moves

Advantages

Liquidity and transparency on major contracts
Standardization simplifies trading and settlement
Leverage: small capital outlay controls a larger notional exposure (efficiency)
Daily marking to market reduces credit risk between counterparties via the clearinghouse

Risks and pitfalls

Leverage magnifies losses as well as gains — margin calls can force positions to close at unfavourable prices
Basis risk: the futures price may not perfectly track the underlying physical price
Rollover/contango/backwardation: when holding futures across expirations, costs or gains of rolling can affect returns
Settlement/expiry mechanics: futures close to expiration may behave differently (lower liquidity, delivery risk)
Operational risk: incorrect sizing, insufficient margin, or poor execution can lead to large losses

Practical tips for beginners

Learn contract specifications (size, tick, margin) before trading a contract
Use position sizing and strict risk management — treat leverage with respect
Practice with simulation or small positions first
Understand how and when to roll contracts if you intend to maintain exposure across expiries

Conclusion

Futures are powerful tools for managing risk and gaining exposure to assets efficiently. Their standardization and exchange clearing make them accessible and safe relative to many over-the-counter derivatives, but leverage and market mechanics require discipline and understanding.

If you're starting out, focus on learning contract specifications, how margin works, and a clear plan for risk management. With those foundations, futures can be a practical part of hedging or trading strategies.

Futures Trading — A Practical Introduction