Deep Dive · Futures · Lesson 1
What Is a
Futures Contract?
Big Idea
A futures contract is a binding agreement to buy or sell a specific asset at an agreed price on a specific future date. Both sides are committed — the buyer must buy, and the seller must sell, when the contract comes due.
- An option gives you a right — you can walk away.
- A future is an obligation — both sides must follow through.
If you remember one thing: futures lock in a price, and they bind everyone to it.
The Four Parts of Every Futures Contract
Every futures contract answers four questions. Because the contract is standardised by the exchange, only the price is negotiated between buyer and seller — the rest is fixed.
| Part | What It Means | Example |
|---|---|---|
| Underlying asset | What is being bought or sold | Crude oil |
| Contract size | The fixed quantity per contract | 1,000 barrels |
| Futures price | The agreed price, locked in today | $75 per barrel |
| Delivery date | When the contract must be settled | In three months |
A Simple Analogy
Imagine it is spring. A bakery knows it will need wheat at harvest time, and a farmer knows they will have wheat to sell. Neither wants to gamble on what the price will be in the autumn.
So they agree today: the bakery will buy a set amount of wheat at a fixed price when the harvest arrives. The farmer is now obligated to sell at that price, and the bakery is obligated to buy at that price — no matter where the market goes. That agreement is the essence of a futures contract.
Both sides trade uncertainty for certainty. That is the whole point.
A Worked Example
Suppose you buy one crude oil futures contract. You are now obligated to buy 1,000 barrels at $75 each in three months.
- Contract size: 1,000 barrels
- Agreed (futures) price: $75 per barrel
- Total value controlled (notional): 1,000 × $75 = $75,000
What happens at expiration depends on the market price of oil:
| Oil Price at Expiry | Your Result | P&L |
|---|---|---|
| $82 | You still pay $75 — $7 below market | Gain $7,000 |
| $75 | You pay exactly the market price | Break even |
| $70 | You must still pay $75 — $5 above market | Lose $5,000 |
Notice the loss is just as real as the gain. A futures buyer who is wrong cannot simply walk away — that is the price of locking in a price.
Right vs. Obligation
This is the cleanest way to tell futures and options apart.
| Feature | Option | Future |
|---|---|---|
| Buyer’s commitment | A right — can walk away | An obligation — must settle |
| Upfront cost | Premium paid to the seller | No premium (a margin deposit instead) |
| Most you can lose | Buyer: the premium | Potentially large on both sides |
| Where it trades | Exchange or over-the-counter | A regulated exchange |
Standardised and Exchange-Traded
Futures are not private handshake deals. The exchange sets the contract size, the quality of the asset, and the delivery dates, so every contract of the same type is identical. That standardisation is what lets futures trade freely between strangers.
A clearinghouse sits between the buyer and seller and guarantees that both sides perform, and each position is marked to market — its gains and losses are settled every day. (More on that in a later lesson.) A privately negotiated version of the same idea is called a forward, and it trades off-exchange.
Why Futures Exist
Hedging
A business removes price risk. An airline locks in fuel costs; a farmer locks in a selling price. The goal is certainty, not profit.
Speculation
A trader tries to profit from price direction, with no intention of ever handling the physical asset. The goal is profit, and the risk is real.
Interactive Checks
Check 1 of 3
You buy one futures contract and hold it to the delivery date.
What are you required to do?
Check 2 of 3
A bakery agrees today to buy wheat at a fixed price at harvest, so its costs are predictable.
What is the bakery doing?
Check 3 of 3
You are comparing a futures contract with buying an option.
Which statement about futures is correct?
Common Beginner Mistakes
- ❌ Treating a future like an option. You cannot simply abandon a future for the cost of a premium — both sides are obligated to settle.
- ❌ Thinking you need the full notional in cash. You control a large position with a smaller margin deposit. That is leverage, and it is covered in a later lesson.
- ❌ Forgetting the short side. Selling (going short) a future is just as normal as buying it — someone is always on the other side.
- ❌ Confusing futures with forwards. Futures are standardised and exchange-traded; forwards are private, customised deals.
Quick Memory Tool
- Future = obligation to buy or sell at a set price on a set date
- Both sides are committed — buyer must buy, seller must sell
- No premium — a margin deposit is posted instead
- Standardised and traded on a regulated exchange
Next Lesson
Long and Short Futures — every contract has two sides. Going long profits when the price rises; going short profits when it falls. Next we trace the payoff of each.