Definition
A futures contract is a standardized, exchange-traded agreement to buy or sell a specified quantity of an asset at a set price on a future date, or to settle the difference in cash. Positions are marked to market daily and backed by margin.
How it works
The exchange sets the contract size, tick size, expiry months and settlement method. Some contracts end in physical delivery, such as certain commodities, while others, such as stock index futures, settle in cash, so delivery is not universal. Most speculative traders close positions before expiry.
Gains and losses are credited or debited daily as variation margin. Unlike an option buyer, both the long and the short carry an obligation, so losses can exceed the initial margin. The futures price is linked to the spot price through carrying costs, and the gap between them, the basis, tends to narrow as expiry approaches.
Formula / convention
Notional value = Futures price × Multiplier × Number of contracts; Long profit or loss = (Exit price − Entry price) × Multiplier × Number of contracts (reverse the sign for a short)
Illustrative example
A fictional index futures contract has a multiplier of HK$50 per index point, so at 20,000 points its notional value is 20,000 × 50 = HK$1,000,000. If the index rises 150 points to 20,150, a long position gains 150 × 50 = HK$7,500 and a short position loses the same amount, settled in cash through daily margin.
What to watch for
Futures profits and losses are settled in cash every day, so a losing position can be hit by margin calls and forced liquidation; always read the contract specifications for delivery and settlement terms.