Lessons › Advanced track › Futures basics

World 10 · Advanced track · lesson 1 · level 4

Futures basics

A future is a promise to buy or sell something later at a price agreed today, and gains and losses are settled every day.

In one line

A futures trader can lose more than the whole deposit. How can a promise about next month cost money today?

Explained simply

A future is like agreeing today on the price of a cake you will collect next month. If cake prices rise, your deal becomes more valuable, and if they fall, it is worth less. With futures, that change in value is paid in cash every single day, not just at the end.

The lesson

A futures contract is a standardized, exchange-traded agreement to buy or sell an asset, such as an index, a currency or a commodity, at a set price on a future date. Traders post initial margin, a good-faith deposit, and every day the exchange's clearing house marks positions to market, moving gains and losses between accounts. If an account falls below the maintenance margin, the broker asks for more money (a margin call), and losses can be bigger than the whole deposit. At expiry, contracts settle either in cash or by physical delivery of the asset.

A worked example

Illustrative example: you buy 1 gold future, which covers 100 troy ounces, at 2,000 dollars an ounce. Say initial margin is 10,000 dollars and maintenance margin is 9,000 (made-up levels, because exchanges set and change real margins). Day 1 settles at 1,990: (1,990 - 2,000) x 100 = -1,000, leaving 10,000 - 1,000 = 9,000. Day 2 settles at 1,985: (1,985 - 1,990) x 100 = -500, leaving 9,000 - 500 = 8,500, which is below maintenance. The margin call asks for 10,000 - 8,500 = 1,500 to bring the account back to the initial level. Each 0.10 move is worth 0.10 x 100 = 10 dollars.

The same idea at four levels

1. Beginner. A future is an agreement to buy or sell something later at a price agreed today.
2. Foundation. You post a deposit called margin, and gains and losses are paid into or out of your account every day.
3. Intermediate. Each contract has a fixed size and a value per point, such as 50 dollars per index point for one E-mini S&P 500 future or 10 dollars per 0.10 move for one standard gold future.
4. Advanced. If your account falls below maintenance margin you get a margin call, and a big move can cost more than your whole deposit, so size by the loss you can afford rather than by the margin you have.
5. Expert. Know every contract's expiry date and settlement type, because a physically delivered contract near expiry, like US crude oil, can behave very differently from a cash-settled index future.

Mistakes to avoid

• Thinking the margin deposit is the most you can lose, when losses can be bigger.
• Ignoring the contract's expiry date and settlement type.
• Sizing by how many contracts your margin allows instead of by the loss you can afford.

Goal of this lesson: Understand how futures contracts work: standard terms, margin, daily settlement and expiry.