What Is a Futures Contract?

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A futures contract is a standardized legal agreement between two parties to buy or sell a specific asset at a predetermined price on a specified future date. The buyer is obligated to purchase the asset and the seller is obligated to deliver it — or settle the difference in cash — at expiration, regardless of where the market price stands at that time.
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Futures contracts are traded on regulated exchanges and are used by a wide range of market participants — from commodity producers managing price risk to institutional investors hedging portfolio exposure to individual traders speculating on price movements, as part of the broader practice of futures trading.

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Key components of a futures contract

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Every futures contract is defined by a standardized set of terms known as contract specifications. These are set by the exchange and cannot be negotiated between individual buyers and sellers. Understanding these components is essential before trading any futures contract.
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Underlying asset is what the contract is based on — a physical commodity such as crude oil, gold, or wheat, a financial instrument such as a government bond or currency, or a market index such as the S&P 500 or the Nasdaq.
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Contract size is the quantity of the underlying asset covered by one contract. Contract sizes are standardized by the exchange and vary significantly across different markets and asset classes.
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Expiration date is the date on which the contract expires and must be settled. Futures contracts are organized by expiration month. The contract with the nearest expiration date is known as the front-month contract and typically has the highest trading volume. Traders who want to maintain exposure beyond a contract's expiration without taking or making delivery may roll their position — closing the expiring contract and opening a new one in the next available expiration month.
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Settlement method defines how the contract is resolved at expiration — either through physical delivery of the underlying asset or through cash settlement, where the difference between the contract price and the market price at expiration is paid in cash. Financial futures — including index futures — typically settle in cash. Commodity futures may involve physical delivery, though most positions are closed before expiration.
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Tick size is the minimum price increment by which a futures contract can move. Each tick has a defined dollar value that determines the gain or loss per contract for each minimum price movement.
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Trading hours differ from stock markets. Many futures contracts trade nearly 24 hours a day, five days a week, reflecting the global nature of the underlying markets.

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How a futures contract is priced

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The price of a futures contract reflects the market's expectation of where the underlying asset's price will be at expiration. It is influenced by the current spot price of the asset, the time remaining until expiration, interest rates, and storage costs for physical commodities.
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As the expiration date approaches, the futures price and the spot price tend to converge. When the futures price is higher than the spot price, the market is said to be in contango — generally reflecting the cost of carrying the underlying asset until delivery, including storage and financing costs. When the futures price is lower than the spot price, the market is in backwardation, which can occur when immediate demand for the underlying asset is high relative to future supply.

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Margin and daily settlement

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Trading a futures contract does not require paying the full value of the contract upfront. Instead, traders are required to post an initial margin — a performance bond set by the exchange that represents a fraction of the contract's total value.
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Futures positions are marked to market on a daily basis. At the end of each trading day, gains and losses are calculated based on the day's closing price and credited or debited to each trader's margin account. This daily settlement means that profits and losses are realized continuously rather than only when a position is closed.
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If losses cause the margin account balance to fall below the maintenance margin — a minimum level set by the exchange — the trader receives a margin call and must deposit additional funds. Failure to meet a margin call may result in the position being liquidated by the broker.

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Futures contracts vs. forward contracts

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Futures contracts are often compared to forward contracts. Both are agreements to buy or sell an asset at a fixed price on a future date, but they differ in structure and risk.
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A forward contract is a private agreement negotiated directly between two specific parties. Its terms can be customized, but because it is not traded on an exchange, it carries counterparty risk — the risk that the other party will fail to fulfill their obligation.
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A futures contract is standardized, exchange-traded, and cleared through a clearing house that acts as the counterparty to both sides of every trade. This eliminates counterparty risk and makes futures contracts fungible — because all contracts of the same type and expiration are identical, they can be freely bought and sold on the open market.

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Futures contracts vs. options contracts

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Both futures and options are derivatives with expiration dates, but they differ in one fundamental way.
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A futures contract is a binding obligation. Both the buyer and the seller are required to fulfill the terms of the contract at expiration — or close the position beforehand.
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An options contract gives the buyer the right, but not the obligation, to buy or sell the underlying asset at a specified price before or at expiration. The buyer of an option can choose not to exercise it if the market moves against them, limiting their loss to the premium paid. This optionality does not exist in futures contracts.

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Conclusion

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A futures contract is a standardized legal agreement to buy or sell a specific asset at a fixed price on a future date. Its key components — underlying asset, contract size, expiration date, settlement method, and margin requirements — are defined by the exchange and apply equally to all participants. Understanding how contracts are priced, how positions are marked to market daily, and how settlement works at expiration is foundational to understanding how futures markets function within the broader financial system.

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