Why futures contract matters
Futures provide liquid, capital-efficient exposure for hedging and investment. Leverage means a small margin deposit controls a larger notional, while daily settlement creates cash-flow demands.
How it is applied
Investors choose contract, month, quantity, and roll policy, then monitor notional, tick value, basis, limits, initial margin, variation margin, and delivery rules. A standardized exchange contract commits parties to a future transaction or cash settlement. Investors select contract, expiry, quantity, and hedge ratio, post margin, and manage daily variation cash flows. Positions are rolled when exposure is needed beyond expiry.
Portfolio example
One index future has $200,000 notional and requires $15,000 initial margin. A 3% adverse index move creates about $6,000 loss despite the smaller deposit. An equity future has multiplier 50 and index level 4,000, giving 200,000 notional. A 2% decline produces about a 4,000 loss per contract, settled through variation margin even though initial margin was much smaller than notional.
How to interpret it
The quoted futures price is not necessarily a forecast. It reflects spot, financing, income, storage, and market conditions. Return on margin can exaggerate apparent gain or loss. Futures provide leveraged exposure because margin is collateral rather than purchase price. Return includes the futures-price move and collateral return. Basis and roll yield can make performance differ from spot movement.
Limitations and common misconceptions
Margin can rise, contracts can become illiquid, and basis may move. Physical delivery, expiry, daily price limits, and roll costs require active management. Margin calls can force liquidation, and gaps can exceed posted collateral. Contract specifications, limits, delivery, expiry, basis, and roll costs matter. A hedge can be imperfect when the futures underlying differs from the actual portfolio. Exposure reporting should show notional, delta-adjusted exposure where relevant, margin posted, and maximum plausible variation call. Contract price can converge to spot through delivery economics, but cash-settled products follow their specified final index. Position limits and roll dates can force trading. Investors should verify whether gains and losses are recognized daily and how excess collateral is invested. Operational readiness matters as much as the directional market view.
Sources and further reading
- Futures GlossaryU.S. Commodity Futures Trading Commission
- Introduction to DerivativesCFA Institute