What’s a futures contract?

The value of your investments and the income you receive from them can go up and down, and you may get back less than you invest. Any examples are for illustration purposes only.

A futures contract (usually just called “futures”) is an agreement between two parties to buy or sell an asset at a specific price on a future date. Futures exist for a variety of products ranging from stock indices to commodities to currencies. All futures contracts are marked to market and have an expiration date. These characteristics, among others, differentiate futures from stocks and options and play key roles in their performance over the life of the contract.

Generally, futures are not used to facilitate the purchase or sale of the underlying asset. Rather, futures traders typically close their contracts ahead of the expiration date. In many ways, futures trading is similar to stock trading - traders attempt to buy low and sell high (or sell high and buy low later). Buyers and sellers of futures trade contracts on regulated exchanges through a futures broker.

Like options, futures contracts are standardised, making them easier to trade. The terms of the contract are called contract specs and specify critical information that every trader should become familiar with before trading a futures contract. Some examples of futures contract specs include:

1. Underlying asset: The product being traded, which can be commodities like oil, gold, silver, and cryptocurrencies, or financial instruments such as stock indices and currencies.
2. Contract size: A standardised quantity of the underlying asset specified in the contract. For example, one crude oil futures contract represents 1,000 barrels of oil, one gold futures contract represents 100 troy ounces, and one bitcoin futures contract represents five bitcoin.
3. Tick size: A tick is a future contract’s minimum price fluctuation. It’s set by the exchange and will vary from one futures contract to the next. For example, the tick size for E-mini S&P 500 futures is 0.25. Meanwhile, the tick size for gold futures is 0.10.
4. Tick value: The amount of money that’s represented by each tick of the contract’s price. It’s calculated by multiplying the contract size by the tick size. For example, because gold futures (/GC) have a contact size of 100 troy ounces and tick size is 0.10, the minimum tick value is $10 per contract (100 x 0.10). For every tick up or down in the price of a gold contract, a trader will make or lose $10 per contract.
5. Trading hours: The times a futures contract is open and available to trade. While many futures trade nearly 24 hours a day, Sunday to Friday, the hours vary from one contract to another and aren’t tied to normal stock market hours.
6. Expiration dates and procedures: All futures have an expiration date. This is the date when the contract no longer trades and must be settled, either through physical delivery of the asset or cash settlement. At Robinhood Derivatives, cash-settled contracts can be traded up to expiration. Meanwhile, physically settled contracts can’t and must be closed by the last day to trade. Nobody wants to wake up one morning with 1,000 barrels of crude oil in their garden.
7. Others: Other contract specs include the futures contract code, or symbol, the grade or quality of the asset, contract listing procedures, position limits, price limits and circuit breaker information, among other details. For a full listing of contract specifications, traders can visit the exchange website where the contract is listed.

Example

The CME Group West Texas Intermediate (WTI) Light Sweet Crude Oil futures (/CL) is one of the most actively traded energy contracts in the world. The contract represents 1,000 barrels of WTI (a US light sweet crude oil blend) and is widely used by producers, refiners and financial traders to hedge against or speculate on changes in crude oil prices, providing a critical tool for risk management and investment in energy markets. Prices are quoted in US dollars and cents per barrel and the minimum price movement, or "tick," is $0.01 per barrel. Because each contract represents 1,000 barrels, each tick equals $10 per contract (1,000 x .01). The contract is traded nearly 24 hours a day, Sunday to Friday, on the CME Globex electronic trading platform. The contract is physically settled, and traders at Robinhood Derivatives would be required to close or roll their position by the last day to trade, which is displayed in the app.

Traders generally use futures contracts in anticipation of price movements in the underlying asset, a.k.a. speculation. If their forecasts are correct, they can potentially make profits but, when they're wrong, they can suffer losses.

There is a wide variety of market participants who use futures to speculate, including individual traders, hedge funds and proprietary trading firms. It’s important to note, these traders don’t necessarily intend to hold the contract until expiration and take delivery of the underlying asset but instead aim to buy low and sell high (or sell high and buy low) to make a profit.

For example, a speculator might buy a crude oil futures contract if they believe oil prices will rise, planning to sell the contract at a higher price before it expires. Because futures trading involves leverage, speculators can control large positions with a relatively small amount of capital, amplifying potential gains as well as potential losses. This ability to speculate on price movements and control relatively large positions with small amounts of capital makes futures an attractive instrument for traders seeking to capitalise on market volatility. Of course, with that comes the need for knowledge, understanding and proper risk management on the trader’s part.

On the other hand, futures are also used as a tool to manage risk, a.k.a. hedging. For example, farmers, oil producers or manufacturers sometimes use futures contracts to lock in prices for their products or raw materials; a farmer might sell a futures contract for corn to secure a guaranteed price at harvest time, protecting against the risk of falling prices. Similarly, an airline company might buy energy futures contracts to stabilise fuel costs and protect against price spikes. By locking in prices through futures contracts, these businesses can manage their risk and ensure more predictable financial outcomes.

You don’t have to be a commercial business to use futures as a hedging tool. A retail trader, for example, can potentially use futures to hedge risk in a stock portfolio. This is sometimes done by selling stock index futures which can help hedge against the risk of falling stock prices, and protect a stock portfolio during market selloffs, corrections and bear markets. However, selling stock index futures also carries unique risks to be aware of and hedging with stock index futures usually requires proper trading mechanics, including position sizing and market timing. The main point is, while some traders use futures to speculate, others use them in an attempt to hedge risk.

The futures market offers a wide range of contracts across multiple asset classes, catering to various market participants. These include commodities like agricultural products (corn, wheat, soybeans), energy (crude oil, natural gas, gasoline), and metals (gold, silver, copper). Financial futures are also available, covering stock indices (S&P 500, NASDAQ 100, Dow Jones Industrial Average, Russell 2000), interest rates (US Treasury bonds, Eurodollars), and foreign exchange (currencies pairs like EUR/USD, AUD/USD). Additionally, the CME has expanded into newer markets, including cryptocurrency futures (Bitcoin, Ether).

Regulated exchanges like CME Group create futures and standardise their specifications, providing a centralised marketplace where contracts can be bought and sold. Exchanges act as a designated counterparty between a buyer and seller. The exchanges validate and finalise the transaction, ensuring that both the buyer and the seller honour their contractual obligations. This process also makes it easier for traders to enter and exit the market while maintaining anonymity between buyers and sellers.

If you’ve traded stocks before, many of the concepts of futures trading will already be familiar to you. Like stocks, futures trade on exchanges and are bought and sold through a broker (note that futures trading requires an approved futures account). Each futures contract will have a last price, a bid price and an ask price. If you think the price of a futures contract is going to rise, you might buy it and, if you think it’s going to fall, you might sell it. While there are similarities, futures and stocks are different in several key ways (note: this isn’t an exhaustive list):

• Futures contracts are derivatives, meaning their value is derived from an underlying asset. Stocks, however, represent ownership in a company.
• When you buy a stock, you purchase a share of the company's equity and may receive dividends and voting rights, which isn’t the case with futures.
• Selling stock short involves borrowing shares from a broker and paying interest based on the borrowing rate. Shorting futures doesn’t; it’s simply the opposite of buying a futures contract (a.k.a. “going long”).
• Unlike stocks, futures contracts have expiration dates. Stocks don’t - you can hold shares indefinitely as long as the company remains publicly traded.
• Stocks are subject to pattern-day trading (PDT) rules, which may limit the number of day trades an individual can place over a period of time. Futures aren’t subject to PDT rules.
• The risks of owning stocks and trading futures are different as well. For example, if a person owns shares, their losses are limited to the amount invested. With futures, an investor deposits money and meets margin requirements, and the potential losses can be greater than the amount invested, including the potential for negative prices.

While there are some similarities, futures aren’t options and options aren’t futures. In fact, some futures have their own options, called “options on futures” or “futures options”. Although not exhaustive, here’s a list of some of the main differences:

• Futures contracts obligate the buyer to purchase, and the seller to sell, a specific asset, at a predetermined price on a future date. Meanwhile, option contracts give the buyer the right, but not the obligation, to buy (call option) or sell (put option) an asset at a predetermined price (the strike price) on or before a specified expiration date. The seller of the option has the obligation to fulfil the contract if the buyer exercises the option.
• At expiration, futures contracts must be settled either by physical delivery of the underlying asset or cash settlement, depending on the contract terms. Options also have expiration dates, but whether or not the contract is exercised typically depends on whether it is in the money or out of the money. The concept of moneyness doesn’t apply to futures as there are no strike prices for futures contracts.
• While the supply and demand of the underlying asset and expectations of its future price are the main determinants of a future’s price, many factors influence the value of an option: the current price of the underlying asset, the strike price, time to expiration, implied volatility and any potential dividends paid prior to the expiration.
• Most futures traders are looking to profit from moves up (bullish) or down (bearish) in the value of the contract. Options traders can express opinions through a variety of strategies that are bullish, bearish, neutral, long volatility, short volatility and others.

Futures are unique financial instruments that differ from stocks and from options in a number of ways and have their own pros, cons, regulations and risks. Often used to hedge or for speculation, a futures contract is a legally binding agreement to buy or sell an asset at a predetermined price on a specific future date. They’re standardised in terms of quality, quantity and delivery specifics, making them easily tradable on the futures exchanges and through a futures broker. Today, futures contracts are available across a wide range of commodities, financial instruments and newer markets like cryptocurrencies.

Important information

When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.

Futures are complex products with a high risk of losing money rapidly due to leverage. They’re not suitable for all investors. Before you invest, you should make sure you understand how futures work, what the risks are of trading futures and whether you can afford to lose more than your original investment. Please review the Futures Risk Disclosure Statement prior to engaging in futures trading.

Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.