Futures Explained Simply: Locking In Today's Price for Later

Ever fixed your energy tariff for the next 12 months? You agree a price today and pay it for the whole year. If market prices shoot up, you're the winner; if they drop, you've overpaid. A futures contract is the same idea, just for gold, oil, wheat, currencies and stock indices, and traded on an exchange.

In this article you'll learn, in plain words, what futures are, who uses them, what margin and daily settlement mean, and why futures prices affect other markets, including forex and CFDs.

What are futures?

The US Commodity Futures Trading Commission (CFTC) describes a futures contract as an agreement to buy or sell something on a set date in the future, with the price and amount fixed today.

Three key features:

• Traded on an exchange: not between you and a broker, but on an official market such as CME in the United States.
• Standardised: contract size, expiry date and rules are the same for everyone.
• Cleared: a clearing house stands in the middle and guarantees that both sides keep their promises.

A fun fact from the CFTC: most contracts are closed before the delivery date. So most traders never want the gold or oil at all; they just trade the price.

Who uses futures?

Two main groups:

• Hedgers: people who actually deal in the product and want protection from price swings. Think of an airline worried about fuel getting more expensive, or a farmer afraid the price of the crop will drop by harvest time. They use futures to lock in a price now.
• Speculators: traders like you who are just after profit from price moves. They make the market busier and make sure hedgers can always find someone to trade with.

Margin and daily settlement: the heart of futures

Margin is a guarantee, not a loan

CME calls futures margin a good-faith deposit: money that shows you can cover possible losses. It isn't a loan and it doesn't give you ownership of anything. It isn't fixed either; the exchange raises or lowers it depending on how volatile the market is.

Daily settlement

In futures, profit and loss don't wait until the end. Every day your account is updated using that day's settlement price: if you made money, cash is added; if you lost, it's taken out. This is called mark to market.

Practical example: the Micro E-mini S&P 500

This example is hypothetical and the prices are simplified.

CME lists a contract called the Micro E-mini S&P 500. According to the official specifications, each index point is worth 5 dollars and the smallest move is 0.25 points, which is 1.25 dollars.

• The index is at 5,000, so one contract is worth 25,000 dollars (5,000 times 5).
• You buy one contract. You set your stop 20 points lower (4,980) and your target 40 points higher (5,040).
• Your risk: 20 times 5, so 100 dollars. Your target profit: 40 times 5, so 200 dollars.
• Day one closes at 5,010: 50 dollars is added to your account.
• Day two closes at 4,995: 75 dollars is taken out.

See? Your account is brought in line with the market every single day, so there are no hidden losses.

Trading hours

CME equity index futures trade almost around the clock: from Sunday at 6 pm New York time to Friday at 5 pm, with a one-hour break each day. For UK readers, that's roughly Sunday 11 pm to Friday 10 pm London time.

How futures connect to other markets

This part really matters, especially if you trade forex or CFDs:

• Futures are a price reference. The futures market is one of the main places where prices are "discovered", and many businesses and investors use futures prices as a benchmark for other deals and decisions. The gold or index CFD price your broker shows you is built from prices in the main markets, and futures are one of the most important of them.
• First to react to weekend news. Because index futures open on Sunday evening New York time, the effect of weekend events usually shows up there first.
• Gold futures and the dollar. Gold futures are priced in dollars, and the World Gold Council says gold has historically tended to move against the dollar. News that moves the dollar moves gold futures too.

Remember, these relationships are not fixed rules and their strength changes over time.

Common mistakes

• Not knowing the contract size: jumping in without knowing what one point is worth. Always read the contract specifications first.
• Forgetting expiry: contracts have an expiry date. If you're not paying attention, you may have to close or roll your position near expiry.
• Underestimating daily settlement: if daily losses eat through your margin, you'll need to add money or your position will be closed.
• Starting with a big contract: micro contracts exist precisely so you can practise with less money.
• Ignoring the knock-on effects: if you trade index CFDs and never look at the futures, you're missing half the picture.

Practical checklist

• I've read the contract specifications: value per point, minimum move and expiry date.
• I've asked my broker about the required margin and minimum balance.
• I've worked out my risk in dollars, not just in points.
• I know when the market opens and closes.
• If I trade CFDs or forex, I also keep an eye on the related futures.

Frequently asked questions

Do I have to take delivery of the goods?

No, not if you close your position before the delivery date. According to the CFTC, most contracts are closed that way. Some contracts don't involve physical delivery at all and settle in cash.

How are futures different from CFDs?

Futures trade on an exchange with standard contracts and a clearing house. A CFD is a direct contract between you and your broker. Futures are more transparent, but contracts are usually bigger.

How much money do I need to trade futures?

It depends on the contract and the broker. Micro contracts were created so people can get started with less capital, but the exchange and your broker set the margin, and it can change.

Why are futures called a price reference?

Because the biggest market players trade huge volumes there, and the price is transparent and the same for everyone. That's why so many other markets keep an eye on it.

Wrapping up

A futures contract is like fixing a price today for something you'll settle later, only standardised, transparent and on an exchange. Its margin is a guarantee, profit and loss are settled every day, and its price is a reference for many other markets. Even if you never trade futures, understanding them helps you see where the prices you see in forex and CFDs come from.

To learn step by step, check out the free courses and take a look at the pro tools in software.

Adapted from: CFTC, CME Group, CME Clearing and World Gold Council

Trading involves a significant risk of loss. This article is for education only and is not financial advice.