Futures contracts allow traders and businesses to lock in prices ahead of time. These contracts specify the asset, the quantity, the price, and the delivery date. Unlike forwards, futures are standardized, exchange-traded, and backed by a clearinghouse, which reduces the risk that one side won’t meet their obligation.
Futures are used in many markets, including commodities (like oil or wheat), stock indexes, interest rates, foreign exchange, and cryptocurrencies. Traders use them to speculate on price movements, while companies use them to hedge against future price changes. For example, an airline might use oil futures to control fuel costs.
Futures are marked-to-market daily. This means gains or losses are settled at the end of each trading day, and traders must maintain margin requirements. This system increases transparency and reduces counterparty risk, making futures one of the most widely used tools in global financial markets.
Futures help companies manage price uncertainty and allow traders to participate in markets with high liquidity and leverage. They also play a major role in setting global benchmark prices.
Futures specify all terms upfront: asset type, quantity, price, and expiration date. Once a trader enters a futures position, the contract is marked-to-market daily, meaning the account is adjusted based on price changes. At expiration, the contract may be settled in cash or by physical delivery of the asset, depending on the exchange rules. Most traders close positions before expiration to avoid delivery.
Businesses rely on futures to stabilize costs and protect profits. For example, a manufacturer may use metal futures to secure prices for raw materials months in advance. This reduces exposure to unexpected price spikes. Hedging with futures allows companies to plan budgets more accurately and reduce financial uncertainty in volatile markets.
Futures allow for leverage, meaning small price changes can produce large gains or losses. Margin calls may occur if the market moves against a trader, requiring additional funds to maintain the position. While clearinghouses reduce counterparty risk, market volatility can still create fast, unexpected moves. Traders must manage leverage carefully and understand contract specifications.
A coffee roaster expects to buy large batches of coffee beans in six months. To avoid price increases, the company buys coffee futures contracts today. When six months pass, the futures position protects the business from rising market prices.
