Futures contract

An exchange-traded agreement to take or make delivery of a stated quantity of a good on a stated future date, held on a deposit far smaller than the notional amount.

Example

One contract on 100 units at 2,000 is a notional 200,000; on 10,000 of margin that is leverage of 20 times, and a 5% adverse move removes the whole deposit.

Important

It is neither a forecast nor ownership. Every contract has a date, so maintaining an exposure means rolling into the next one repeatedly, at whatever the curve costs at the time.

Related terms

• Contango — A futures curve sloping upward, with dated prices above the spot price - the ordinary state of a good that is plentiful and expensive to store.
• Backwardation — A futures curve sloping downward, with dated prices below the spot price - what happens when a good is scarce now and buyers will pay a premium to have it immediately.
• Roll yield — The gain or loss a futures holder takes each time an expiring contract is replaced with a later one, as the expiring contract converges to the spot price.
• Leverage — Investing with borrowed money so that you control more of an asset than your own capital would buy. Gains and losses are both multiplied by the same factor.
• Cost of carry — What it costs to hold a physical good until a future date: financing on the capital tied up, plus storage and insurance.

Lessons that explain it

• A physical good, and three very different ways to own it — Metal in a vault, a listed product that holds metal, and a dated contract on metal are not three versions of one investment. They differ in minimum size, cost, storage and who owes you what. (9 min)
• The curve, and why a fund can lag the price it tracks — Spot is set by physical supply and demand. Everything dated is set by the cost of carrying the good to that date - and when the curve slopes upward, a fund that holds contracts loses money every time it rolls, even with the price standing perfectly still. (12 min)
• A contract about a price, not a piece of anything — An option or future is an agreement whose value depends on another asset. You own a right or an obligation with an expiry date, not a share of a business. (10 min)
• Big percentages on a small bet, and most bets expire worthless — Option payoffs are lopsided: a bought option can multiply its premium or lose all of it, and the price usually has to move a long way just to break even. (12 min)

All 578 terms in the Investing glossary