What is a Futures Contract?

A futures contract is an agreement between a buyer and a seller which requires the seller of the futures contract to deliver a specific underlying asset at a certain date and price in the future.

What is a Futures Contract?

A futures contract is an agreement between a buyer and a seller which requires the seller of the futures contract to deliver a specific underlying asset at a certain date and price in the future. The delivery price can is similar to the strike price of an options contract. The price that the contract will be delivered at is known as the futures price.

Futures contracts are binding agreements between the buyer and the seller. Both parties must fulfill the contractual agreements set forth in the future contract. The futures contract will either call for a cash settlement or physical commodity settlement. When buyers and sellers cannot meet the contractual agreements of the futures contract, they will take an offsetting position by buying back a short position or selling a long position.

Futures Contract Specifications

To prevent confusion, all of the terms of a futures contract are pre-defined. There are six key components of a futures contract:

1. Name of Commodity — This is the underlying security and can be an index such as the S&P 500 or even a commodity such as gold, silver, corn, and other agricultural goods.

2. Delivery Date — Defines the date on which the there will be cash or physical commodity settlement
3. Size — Contract size varies in each underlying futures contract. For example, one gold contract will buy you 100 fine troy ounces of gold.
4. Quality — The futures contract will specify the grade of the underlying commodity that you are buying or selling. Using gold as an example, the following definition is given for the quality of the deliverable: 100 troy ounces (±5%) of refined gold, assaying not less than .995 fineness, cast either in one bar or in three one-kilogram bars.
5. Delivery Instructions — Many indices and commodities will opt for cash settlement; however, for those futures contracts that require physical delivery, pickup locations will be specified in the contract.

Margin Requirements

Every futures contract has different specifications in terms of the margin requirements ; however, you need to be concerned with two numbers here:

Initial Margin

Initial margin will specify the amount of funds that will be required to be available in your futures account to purchase one futures contract. Intraday margin requirements are less than those of positions which are held overnight.

Margin Maintenance

Maintenance margin only comes into play when you are in a losing position. A maintenance margin stipulates the minimum amount of cash that must be on hand to avoid receiving a margin call from your broker. For example, assume you purchased one gold contract (100 oz gold) with an initial margin of $3,362. The maintenance margin on the gold contract is $2,490 and therefore stipulates that you must maintain a cash balance in that amount. When I say cash balance, that includes the value of the futures.