What are futures—and what are futures contracts?

Imagine you run a bakery.

Every week, you need flour to make bread. You know roughly how much flour you’ll need over the next few months, but you don’t know what it will cost by then.

If the price rises sharply, your bread becomes more expensive to produce.

Now imagine the other side.

A farmer is growing wheat. The crop won’t be ready to sell for several months.

The farmer has a different concern: what if wheat prices fall before the harvest?

The bakery is concerned about paying more. The farmer is concerned about receiving less.

Both face uncertainty about a future price.

One possible response is to agree on a price today for a transaction that will happen later.

That idea helps us understand why futures markets exist.

But an agreement between two businesses isn’t automatically a futures contract.

Let’s build the distinction.

From an agreement to a futures contract

Suppose the farmer and bakery negotiate their own agreement.

They decide the amount of wheat, its quality, the price, and when and where it will be delivered.

That kind of privately negotiated arrangement is called a forward contract.

A futures contract works differently.

It has standardized terms established by an exchange—a marketplace organized for trading.

“Standardized” means participants aren’t writing a new agreement from scratch every time they trade.

The contract specifies things such as what it represents, its size, when it expires, and how its obligations will be settled.

Buyers and sellers trade that defined contract at prices available in the market.

So, at its foundation, a futures contract is a binding agreement involving a specified asset, an agreed price, and a future settlement date.

Some contracts involve delivery of a physical product. Others settle through money payments under the contract’s rules.

We’ll come back to that difference.

What does “futures” mean?

You might hear someone say:

“I trade futures.”

“Futures” is the usual shorthand for futures contracts.

And when someone refers to a futures market, they’re talking about a market where those contracts trade.

They aren’t buying “the future.” And the name doesn’t mean they know what will happen next.

The word refers to the contract’s future settlement.

That also doesn’t mean every futures trader holds a position for months.

A contract can have an expiration date months away while a trader opens and closes a position in it today.

The contract’s lifespan and the trader’s holding time are two different things.

What can a futures contract represent?

Futures aren’t limited to wheat.

There are contracts connected to physical products such as oil and gold.

There are also contracts connected to financial markets, including currencies and stock indexes.

A stock index measures the performance of a defined group of stocks.

When you trade a stock-index futures contract, you aren’t directly buying each company’s shares.

You’re taking a position in a contract whose value is tied to that index.

This is why knowing the instrument matters.

Buying a company’s stock, buying a physical commodity, and buying a futures contract connected to a market are different transactions.

They can expose you to related price movements while giving you different obligations.

Why do people use futures?

Let’s return to the farmer and bakery.

They already face price risk through their businesses.

They may use futures to help manage that risk. This is called hedging.

For example, a wheat producer may sell wheat futures to help offset the effect of falling wheat prices on the crop they expect to sell.

A business concerned about rising wheat prices may buy wheat futures to help offset increases in its purchasing costs.

Those hedges aren’t automatically perfect. The actual product, timing, and prices may differ from the futures contract.

But the purpose is to manage an existing exposure.

Other participants use futures for speculation.

They take on price exposure because they aim to profit from a change in the contract’s price.

They may have no wheat to sell and no bakery to supply.

A person trading futures based on an expectation that prices will rise or fall is generally participating as a speculator.

These are different reasons for entering the same market.

What does a trader actually do?

Suppose a trader buys one futures contract.

That opens a long position.

A rising price benefits that position. A falling price works against it.

To close the position, the trader can sell an equivalent contract in the same market and expiration month.

That closing transaction offsets the position.

A trader can also sell first, opening a short position.

A falling price benefits the short position. A rising price works against it.

The trader can close it by buying an equivalent contract.

The dollar gain or loss depends on the price change, the contract’s specifications, the number of contracts, and trading costs.

We’ll walk through those calculations in the next lesson.

Does trading futures mean receiving a delivery?

Some futures contracts have physical delivery arrangements.

Others are cash-settled, meaning their final settlement is calculated and paid in money according to the contract’s rules.

Many traders close their positions before the delivery or final settlement process.

But closing beforehand doesn’t make expiration irrelevant.

You still need to know the contract’s rules and your broker’s deadlines.

You shouldn’t discover what a contract requires after you’ve entered it.

One important risk distinction

A futures position requires margin.

Here, margin is money required to support your obligations. It isn’t simply the purchase price of the contract, and it isn’t a limit on your possible loss.

Futures can give you exposure much larger than the money required to open the position.

That’s leverage.

It can magnify gains and losses relative to the capital you put up. Losses can exceed your initial deposit.

Understanding that is part of understanding the product itself.

What you should understand now

“Futures” refers to futures contracts.

Those contracts have defined terms, trade through exchanges, and involve future settlement.

People use them for different purposes, including managing price risk and trying to profit from price changes.

As a trader, you can open and close a position before the contract expires. But you still need to understand what it represents and what obligations come with it.

The next step is to make the mechanics visible.

What does one contract mean?

What are points and ticks?

And how does a movement on a chart become a dollar gain or loss?

That’s what we’ll work through in the next lesson.