Futures in Depth
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A futures contract is a standardized derivative traded under defined contract specifications. It creates an obligation linked to an underlying asset, index, rate, or other reference. At Foundation level, we need to understand contract structure, margin, settlement, and leverage because the futures price alone does not describe the full exposure.
Contract specifications
A futures contract specifies elements such as the underlying, contract size, price quotation, tick size, expiration, and settlement method. These details determine how much a one-point or one-tick move is worth to the position.
Margin is not the purchase price
Futures use margin as performance collateral rather than requiring the full notional value to be deposited in the same way as a fully paid cash purchase. This creates capital efficiency, but it also means that a relatively small price movement can produce a large percentage change relative to the margin posted.
Mark-to-market
Futures positions are generally marked to market, meaning gains and losses are settled or reflected according to the contract’s clearing and margin framework. We therefore need to distinguish notional exposure from the cash or collateral required to maintain the position.
Leverage and risk
Leverage does not make the underlying market less risky. It changes the relationship between our capital and our market exposure. If the contract controls a large notional amount relative to our account, a relatively small adverse move can consume a significant part of available capital.
Trader application
Before trading a futures contract, we should know the contract multiplier, tick value, expiration, settlement method, initial and maintenance margin requirements, and the market’s liquidity. These details are part of the instrument itself, not optional technicalities.
Key Terms
Futures, contract size, tick size, expiration, settlement, margin, leverage, mark-to-market.
Knowledge Check
- Why is contract size important when trading futures?
- Why is margin different from the full notional value?
- How can leverage amplify account-level risk?