What Are Futures?

Futures Contracts Explained

Definition

A futures contract is the agreement to buy an asset at a set price and amount at a future date. Futures contracts are used by businesses to hedge risks, and traders use futures to speculate on both the future of one commodity and the market in general.

Person drinking coffee while looking at a trading screen
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Key Takeaways

  • A futures contract is an agreement to trade a commodity, currency, or stock at a set price, amount, and date.
  • Businesses use futures contracts to hedge risk, and traders may use them to place speculative bets.
  • Futures can be traded with over 30x leverage and are risky because of that leverage.

How Do Futures Work?

Futures contracts are derivatives that lock the price and amount of a commodity, currency, or stock trade in advance. Futures generally trade on an exchange such as the CME Group, where speculators can be matched with one another and business owners to trade futures contracts.

The date set in the futures contract is called the expiry date and trade in ticks. Ticks are the smallest price increment for a trade and are generally one cent. The exception is S&P 500 futures, which have ticks equal to a quarter on an index point.

Note

Settling a futures contract on expiry can either occur with the delivery of the underlying or in cash, depending on the type of contract you have. For example, stock index futures are cash settled.

Futures that trade on an exchange generally have a standardized contract, set by the exchange, and have no counterparty risk because the exchange clears all trades.

Why Trade Futures?

Business owners generally use futures contracts to hedge risk. For example, a corn farmer can use a futures contract to lock in a certain price for their corn months ahead of time. An airline can use futures to hedge against the risk of rising fuel prices.

Traders can use futures contracts to speculate. Individuals can trade futures using a brokerage account such as Schwab or TDAmeritrade.

Futures trading is known for its leverage. Where equity trading typically requires 50% equity, futures trading can be done with as little as 3%. That means for every $1,000 in the trade, you only need to put $30 down. This level of leverage makes trading futures one of the riskiest investments.

Note

Since futures are extremely risky investments, they may not be suitable for all individual investors.

Example of Futures

Let’s say a soybean farmer is worried that soybean prices will collapse prior to harvest and wants to lock in a price for part of the potential harvest now. The farmer can use a brokerage account or even the CME Group website to look through current quotes for different futures contracts (they are designated by date, so futures due in November would be called NOV Soybean Futures).

If the farmer finds a price that guarantees sufficient profit, they can sell the contract and deliver the soybeans at the contract date.

Types of Futures

Futures can be based on a wide variety of underlying assets. Here are some different types of futures contracts:

  • Financial futures: Financial futures include stock indexes, commodity indexes, and U.S. Treasury debt instruments.

Note

Single stock futures that were introduced in the U.S. in 2012 stopped trading in 2020 after OneChicago—the exchange where they were traded—shut down.

  • Currency futures: There are several currencies available for trading via futures contracts, including everything from the U.S. dollar and the Brazilian real to cryptocurrencies such as bitcoin and ethereum.
  • Energy futures: Energy futures include crude oil, natural gas, and other petroleum products such as gasoline and heating oil as well as ethanol.
  • Agricultural futures: These include grain, livestock, and food and fiber futures such as wheat, cattle, and coffee respectively.
  • Metal futures: Precious metals such as gold and silver, and industrial metals like copper can be traded.

Futures Costs and Trading Requirements

Futures trading costs are commissions to the broker. For example, Charles Schwab charges $2.25 per trade. Exchange and regulatory fees are also charged. Exchange fees vary by product, and regulatory fees are two cents per contract.

Note

Futures trading requirements are far more lax than equity trading requirements. For day traders who trade stocks, there’s a minimum margin requirement of $25,000. For futures traders, depending on the type of contract, a typical margin account could be a few hundred dollars.

Futures vs. Options

Options and futures are both derivatives; the difference is obligation. Futures contract agreements obligate the seller to deliver on the contracts’ dates. Options contracts give the buyer the right, but not the obligation, to either buy or sell the contract by the maturity date.

Alternatives to Futures

Investors who want to speculate on commodities but don’t want to use margin or set up a special account to trade futures can use exchange-traded funds (ETFs) or exchange-traded notes (ETNs) to invest in commodities.

Frequently Asked Questions (FAQs)

What are Dow futures?

Dow futures are contracts based on the Dow Jones Industrial Average. Dow futures can be used to predict short-term stock-market movements while the market is closed or to speculate on the market direction over the medium term.

How do you trade futures?

Futures are traded on an exchange such as the CME Group through brokerages such as TDAmeritrade and Charles Schwab.

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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. CME Group. “Futures Contracts Compared to Forwards.”

  2. CME Group. “Tick Movements: Understanding How They Work.”

  3. Commodity Futures Trading Commission. “Basics of Futures Trading.”

  4. CME Group. “The Benefits of Futures Margins.”

  5. Charles Schwab. “Understanding Futures.”

  6. U.S. Securities and Exchange Commission. "OneChicago, LLC’s Notice of Withdrawal of Registration as a National Securities Exchange Solely for the Purposes of Trading Security Futures Products."

  7. Charles Schwab. “Why Trade Futures With Schwab?

  8. TD Ameritrade. “Pricing.” Click on Futures tab.

  9. FINRA. “Am I a Pattern Day Trader? Know the Day-Trading Margin Requirements.”

  10. TradeStation. “Futures Margin Rates.”

  11. Charles Schwab. “Commodity ETFs.”

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