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What Is a Futures Contract? Commodities, Leverage, and Risks
Futures contracts obligate you to buy or sell an asset at a predetermined price on a future date. Here's how they work in commodities, indices, and crypto.
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Futures contracts obligate you to buy or sell an asset at a predetermined price on a future date. Here's how they work in commodities, indices, and crypto.
This guide is designed for first-pass understanding. Start with core terms, then apply the framework in your own account workflow.
A futures contract is one of the oldest financial instruments in existence; farmers and merchants have used them in some form for centuries. At its core, a futures contract is a simple agreement: two parties agree to buy and sell a specific asset, at a specific price, on a specific future date. That's it. But the simplicity is deceptive, because futures markets move trillions of dollars daily and influence the price of everything from your morning coffee to your mortgage rate.
A futures contract is a legally binding agreement to buy or sell a specific asset at a predetermined price on a specific future date. Unlike options, futures obligate both parties to complete the transaction. They trade on regulated exchanges like the CME and cover commodities, stock indices, currencies, interest rates, and cryptocurrency.
Let's start with a straightforward example. Suppose it's January and a wheat farmer expects to harvest 5,000 bushels in July. The current price of wheat is $7 per bushel. The farmer is worried that by July, the price might drop to $5. A bread company, meanwhile, is worried that prices might spike to $9.
They enter a futures contract: the farmer agrees to sell 5,000 bushels at $7 per bushel in July, and the bread company agrees to buy at that price. Both sides get certainty. The farmer knows they'll receive $35,000. The bread company knows they'll pay $35,000. Neither has to worry about price fluctuations anymore.
This is the essence of futures: transferring price risk from one party to another. The farmer gave up the possibility of selling at $9 (if prices rose) in exchange for protection against selling at $5 (if prices fell). The bread company gave up the possibility of buying at $5 in exchange for protection against paying $9.
Modern futures don't work like handshake deals between a farmer and a baker. They're standardized contracts traded on regulated exchanges, with the Chicago Mercantile Exchange (CME) being the most prominent. Standardization means the exchange defines:
Standardization is crucial because it creates liquidity. When everyone is trading the same contract, there are always buyers and sellers, and you can enter and exit positions quickly. The exchange's clearinghouse also acts as the counterparty to every trade, eliminating the risk that the other side defaults on the contract.
A futures contract is an agreement to buy or sell a specific asset at a predetermined price on a specific future date. Unlike options, futures obligate both parties to complete the transaction. Futures trade on exchanges (CME, ICE) and cover commodities (oil, gold, wheat), financial indices (S&P 500), currencies, and crypto.
Futures obligate both buyer and seller to complete the transaction at expiration. Options give the buyer the right, but not the obligation. Futures have symmetric risk (both sides can lose equally). Options have asymmetric risk (buyer can only lose the premium paid). Both provide leverage and are used for hedging and speculation.
Contango is when futures prices are higher than the spot price — markets expect prices to rise (or storage costs are high). Backwardation is when futures prices are below the spot price — markets expect prices to fall. Contango creates a negative 'roll yield' for long-term holders of commodity ETFs, which is why they often underperform the spot commodity.
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You don't need to put up the full value of a futures contract to trade it. Instead, you post margin; a good-faith deposit that's typically a small percentage of the contract's value. This creates significant leverage.
Example: one E-mini S&P 500 futures contract might have a notional value of around $250,000 (at an index level of 5,000). The initial margin requirement might be $12,000; roughly 5% of the contract value. That means you're controlling $250,000 worth of market exposure with $12,000, giving you approximately 20:1 leverage.
This leverage works both ways:
The exchange also sets a maintenance margin; the minimum balance you must maintain. If your account falls below this level, you'll receive a margin call requiring you to deposit more funds immediately. If you can't meet the margin call, the exchange will liquidate your position.
Unlike stocks that you can buy and hold indefinitely, futures positions are settled daily through a process called "mark-to-market." At the end of every trading day, the exchange calculates the profit or loss on every open position based on that day's closing price.
If you're long (bought) one crude oil futures contract at $75 per barrel and the settlement price is $76, you receive $1,000 (1,000 barrels times $1). If the settlement price is $74, you pay $1,000. This cash actually moves in and out of your account every single day.
Daily settlement serves two purposes. First, it reduces counterparty risk by ensuring that losses don't accumulate unchecked. Second, it makes margin calls happen early; before a position has moved so far against a trader that they can't cover their losses. This is one reason why exchange- traded futures are considered safer than OTC forward contracts, which settle only at expiration.
Commodity futures are the original use case and remain a massive part of the market. The major categories include:
Most commodity futures traders never take physical delivery. If you hold a crude oil contract to expiration, you could theoretically be obligated to accept 1,000 barrels of oil at a delivery point in Cushing, Oklahoma. In practice, speculators close their positions before expiration. But sometimes things go wrong; in April 2020, WTI crude oil futures briefly wentnegative, meaning sellers were paying buyers to take oil off their hands, because storage was full and nobody wanted delivery.
Financial futures have grown to dwarf commodity futures in trading volume. The major types:
Stock index futures are particularly important because they trade almost 24 hours a day, five days a week. When you hear about "futures pointing higher" or "futures down sharply" before the market opens, they're talking about S&P 500 futures. They're the market's best estimate of where stocks will open.
Two terms you'll encounter in futures markets that sound complicated but are actually straightforward:
Why does this matter for regular investors? If you own a commodity ETF that holds futures, contango is your enemy. The ETF must regularly "roll" expiring contracts into new ones, and in contango, the new contracts are more expensive. Over time, this roll cost can cause the ETF to significantly underperform the spot commodity price. This is why many oil ETFs lost money even when oil prices recovered; contango ate their returns.
Futures and options are both derivatives, but they work differently in important ways:
| Feature | Futures | Options |
|---|---|---|
| Obligation | Both parties must transact | Buyer has the right, not obligation |
| Upfront cost | Margin deposit only | Premium paid to seller |
| Maximum loss (buyer) | Theoretically unlimited | Limited to premium paid |
| Daily settlement | Yes (mark-to-market) | No (except margin for sellers) |
| Leverage | High (5-20x typical) | Built into premium pricing |
| Best for | Hedging, directional bets with high conviction | Defined-risk strategies, income generation |
Futures markets serve several distinct groups of participants:
Cryptocurrency futures have become a major part of the digital asset ecosystem. There are two main venues:
The crypto futures market regularly processes more volume than the spot market, meaning more people are trading derivatives on Bitcoin and Ethereum than actually buying and selling the assets themselves. This has significant implications for price discovery and volatility.
If you hold crypto assets, tracking them alongside your traditional investments gives you a clearer picture of your overall exposure. Clarity connects to exchanges and wallets to provide that complete view; so you can see how your crypto positions fit into your broader portfolio.
Futures are powerful but dangerous. Key risks to understand:
Even if you never trade futures directly, they likely affect your portfolio. Commodity ETFs, managed futures funds, and crypto derivatives all use futures contracts under the hood. Clarity connects to your brokerages and exchange accounts to show how these instruments fit into your overall asset allocation — so you can see your total exposure to commodity markets, leveraged positions, and derivative-heavy funds in one view alongside your stocks, bonds, and crypto.
Futures are not beginner instruments, but understanding them is valuable even if you never trade them directly. They influence the price of gas at the pump, the interest rate on your mortgage, and the performance of commodity ETFs in your portfolio. If you own any commodity-linked ETFs, check whether they hold futures — and research how contango or backwardation might be affecting your returns.
If you're interested in trading futures, start with paper trading (simulated) to understand the mechanics without risking real money. Learn margin requirements, daily settlement, and contract specifications before committing capital. Resources like the CME Group Education Center and the CFTC Consumer Education page provide free learning materials. And never, ever trade leveraged products with money you can't afford to lose. The leverage in futures markets can make you money quickly — but it can take it away even faster.
This article is for educational purposes only and does not constitute financial or investment advice. Futures trading involves substantial risk of loss and is not suitable for all investors. Past performance does not guarantee future results.