What Are Futures? What You Need to Know

The futures market can offer insight into everything from fuel prices for your next road trip to the cost of groceries in the months ahead—and it also plays a key role in many trading strategies. But what are futures contracts, how do they work, and why do they matter to traders and investors? Ahead, we'll cover the basics of futures, some example strategies and their designed intent, and more.

Futures contracts are standardized agreements to buy or sell an asset at a set price on a specific date in the future. These contracts trade on regulated exchanges and are used by both businesses and individual traders in an attempt to manage risk or speculate on price changes.

Companies often use futures to hedge against price swings in the commodities they produce or need. Traders, on the other hand, often use them to speculate on price movements. Futures can offer opportunities, but they also carry significant risks and aren't right for everyone.

Futures contracts are regulated by the Commodity Futures Trading Commission (CFTC), an independent U.S. agency that oversees the futures and options markets to ensure integrity and transparency. Most futures contracts trade electronically on exchanges like the CME Group, the largest futures exchange in the United States.

While early forms of futures contracts date back to rice markets in Japan in the early 1700s, modern futures trading began in the United States around 1848. That's when a group of grain merchants established the Chicago Board of Trade (CBOT) to bring more structure and reliability to agricultural markets.

Futures contracts evolved as a strategy designed to manage risk on both sides of a transaction. Buyers wanted assurance that they'd receive a consistent quantity and quality of goods—even if the growing season was poor. Sellers, like farmers, needed protection from price crashes caused by bumper crops or oversupply. Futures helped both parties plan ahead and stay in business, even in unpredictable conditions.

Exchanges provide a central forum for buyers and sellers to come together—originally in person, now almost entirely electronically. For more than a century, traders wore colorful jackets and gathered in tiered "pits" on the trading floor, shouting and using hand signals to place orders. This system, known as open outcry, has largely been replaced by electronic trading platforms.

Today, most futures trading takes place online through global exchanges like the CME Group. These platforms operate nearly 24 hours per day during the trading week, allowing participants to respond to market-moving news across different time zones. These extended trading hours are especially important for markets tied to global commodities, currencies, and financial indexes.

Exchanges also play a critical role in ensuring that futures contracts are honored. Most operate clearinghouses, which act as intermediaries—or counterparties—to every trade. This structure helps reduce counterparty risk and ensures that both sides of a contract meet their financial obligations, even if one party defaults.

Futures traders come from a wide range of backgrounds, and their participation helps keep the market liquid and efficient. Broadly, these participants fall into two main categories: commercials and speculators.

Commercials include commodity producers and processors—such as transportation companies, grain millers, and metals miners—who use futures to hedge against price fluctuations in the goods they produce or consume. For example, a grain processor might use futures to protect against the risk of a summer drought that could send corn and soybean prices soaring.

Speculators, on the other hand, trade futures to profit from price movements. This group includes hedge funds, institutional investors, professional traders, and individual retail traders. Like in equity markets, speculators aim to "buy low and sell high" (or vice versa), capitalizing on volatility in futures prices.

Each group plays a vital role. Commercials bring real-world supply and demand to the market, while speculators provide the liquidity that allows trades to execute efficiently. The presence of both ensures a steady flow of willing buyers and sellers—just as in stock and bond markets.

Futures trading involves significant risk and is not suitable for all investors. This is especially true for intraday or short-term trading strategies, where positions may be opened and closed within the same session.

Many trading platforms offer real-time data, risk management tools, and educational resources to help traders monitor their positions. However, no tool can eliminate the inherent risks of leveraged trading. Even small futures price movements can lead to losses that can exceed a trader's initial investment. Managing position sizes, monitoring margin levels, and understanding the risks that come with market volatility are essential skills for any trader looking to use futures. Futures trading comes down to preparation, discipline, and a clear understanding of how these markets function.

Past performance is not indicative of future results. Always consider your financial situation, risk tolerance, and investment goals before trading futures.

In the equity market, buying on margin means borrowing money from a broker to purchase stock—effectively, a loan from the brokerage firm. Margin trading allows investors to buy more stock than they normally could.

Margin works differently in the futures market, even though the basic concept is similar to margin in stock trading. In futures trading, margin is not borrowed money. When trading futures, a trader will put down a good faith deposit called the initial margin requirement. The initial margin requirement is also considered a performance bond, which ensures each party (buyer and seller) can meet their obligations of the futures contract. Initial margin requirements vary by product and market volatility, and are typically a small percentage of the contract's notional value. This type of leverage carries a high level of risk and is not suitable for all investors. Greater leverage can create much greater losses quickly and with small price movements of the underlying futures contract.

An individual or retail investor who wants to trade futures must typically open an account with a futures commission merchant (FCM) and post the initial margin. If prices move against a trader's position, they may receive a margin call, which means more funds must be added to the trader's account. If the trader doesn't supply sufficient funds in time, the position may be liquidated. It's important to understand that your financial risk is not limited to the amount of equity in your trading account. Losses can exceed your initial investment, and any or all your positions may be closed without notice if your account equity falls below margin requirements. 

Nearly all futures contracts follow a standardized format. Each contract spells out specific terms that are set by the exchange including:  

• The grade and quantity of the underlying asset, which can be a commodity, financial instrument, or currency.
• The type and unit pricing of the asset and minimum price fluctuation (tick size).
• The expiration date and location for physical "delivery" of the underlying asset (but actual delivery rarely happens because most contracts are cash-settled or liquidated before the delivery date).  

Let's look at some examples.  

In this scenario, a short-term trader believes the S&P 500® index (SPX) will rise over the next month following a series of strong earnings reports from some of its component members. To act on this view, the trader buys one December Micro E-mini S&P 500 futures contract at a price level of 5,000 index points. The notional value of this position is $25,000. However, the initial margin required to open the position is likely to be between 3% and 12% of that notional value.

Each point of movement in the contract is worth $5. If the index rises to 5,050 index points, the trader could close their position by selling an offsetting December contract, securing a gain of 50 points × $5 = $250.

However, if the index falls to 4,950, the trader incurs a $250 loss. This example illustrates how futures can be used for short-term speculation based on market conditions like earnings announcements, economic data, or Federal Reserve policy updates. 

A trader who studies seasonal trends notices that natural gas futures prices historically rose in late summer as utilities begin building up supply for winter. Based on this pattern—and recent weather forecasts—they believe futures prices may climb over the next month.

The trader buys an August Natural Gas futures contract (/NQ) at $3 per million British thermal units (MMBtu). The contract size is 10,000 MMBtu, making the notional value of the position $30,000. However, the initial margin requirement to open the position is likely to only be between 3% and 12% of that value.

The trader places an order to sell at a target price of $3.40 and a stop order—an instruction to a broker to automatically activate a sell order if the price falls to a certain price—at $2.85 in an attempt to manage risk. Over the next few weeks, futures prices rise as expected, and the trader's order to sell the open August futures contract is filled at $3.40, closing the position. This would  result in a gain of $0.40 × 10,000 = $4,000.

If, instead, futures prices fell to the $2.85 stop-loss level, the stop order would be activated, creating an exchange-designated limit order to sell the position. If this order was filled at the stop price of $2.85, the loss would be $0.15 ×10,000 = $1,500. However, a futures stop order does not guarantee the order will be filled, or that it will be filled at the desired stop price.

This example shows how futures can be used not just for day trading or hedging, but also for short- to medium-term speculation strategies based on market cycles and technical analysis.

A grain producer is concerned that corn prices may decline by harvest time due to favorable weather and strong global supply. In an attempt to protect against this risk, the producer uses a hedging strategy by selling a December Corn futures contract (/CZ) while futures prices are still favorable at $5 per bushel.

Each contract represents 5,000 bushels, making the notional value of the position $25,000. However, the initial margin requirement to open the position is likely to be between 3% and 12% of that notional value.

As harvest time approaches and the corn futures price drops back to $4.50 per bushel, the producer buys back the October corn futures contract at that price, securing a gain of $0.50 × 5,000 = $2,500.

This gain helps offset the lower revenue from selling the physical corn at market prices. While some investors use ETFs or index futures to gain broad exposure to commodities, producers often prefer direct futures contracts for more precise price protection. This example highlights how futures can serve as a tool aimed at helping to manage income risk in volatile agricultural markets. Note: Short futures positions like the one described in this example create unlimited risk, as there is no limit to how high the contract price can go when attempting to buy it back and close the position.

All the examples shown do not include commissions, taxes, or fees in their profit or loss calculations. The leverage used in these examples would amplify losses if prices moved against these hypothetical traders. Because futures are marked to market daily, the gains and losses discussed would have been realized incrementally as futures prices shifted. Initial margin requirements are set by exchanges (though brokers may require additional margin) and are subject to change depending on market conditions and other factors. 

Futures can be powerful tools for both hedgers and speculators. They offer an accessible way to gain exposure to a wide range of markets—from commodities and currencies to equity indexes and fixed income products—often using a relatively small amount of initial capital. However, this accessibility comes with substantial risks because leverage can easily amplify both gains and losses. These losses can greatly exceed a trader's initial capital investment. 

This basic overview only scratches the surface of the complex futures market. Traders should consider learning more about futures trading strategies, margin requirements, and risk management before placing a trade.