What is a futures contract?

What is a futures contract?

A futures contract is a legally binding agreement to buy or sell an asset at a predetermined price by a specific expiry date. The buyer of a futures contract has the obligation to receive the underlying asset, while the seller is obliged to part with their asset for the contracted price.

Futures contracts are typically traded on exchanges, which means they're highly regulated and standardised to ensure the same quality and quantity per contract. While they’re commonly associated with commodities trading, there are other asset classes available to you, including indices and government bonds.

Futures contracts are often contrasted with spot contracts, which enable you to exchange an underlying asset at the current market price – or ‘on the spot’ – rather than on a date in the future. In a spot contract, you’d have the same settlement opportunities as with futures.

Futures are also compared to options, as both contract types enable you to buy and sell an underlying asset for a specific price on a future date. However, unlike futures, options contracts give the buyer the right to leave the contract to expire worthless – they’re not obliged to fulfil the contract at expiry.

With us, you can either trade listed futures or you can trade on futures, options and spot prices using our derivative products – spread bets and CFDs.

Ready to trade futures? Open an account with us today or practise trading in a spread betting or CFD trading demo account.

How do futures contracts work?

Futures contracts work by tracking the spot price of an underlying market and taking other factors into account, such as volatility, the time until delivery, interest rates and the costs of maintaining a position – known as the cost of carry.

Futures prices are often higher than the spot price as they add in all these factors. In this circumstance, the market is said to be in contango. Alternatively, when futures prices are lower than the spot price, the market is in backwardation. When a futures contract expires, it will be equal to the spot price.

At expiry, you could choose to roll your contract and continue to hold the position. Otherwise, you’d have to settle your futures contract using one of two methods: physical or cash settlement.

Physical settlement involves taking delivery of the asset in question if you bought it, or delivering it if you sold it – this is common for businesses that rely on commodities or deal in currencies. For example, say an airline wants to lock in the price of fuel to avoid an increase in costs, they could buy a futures contract for a set amount of fuel at a set price for delivery in the future.

Not everyone involved in the futures market will be looking to exchange the underlying asset at expiry, so they’d settle in cash instead. This is commonly used among speculators and hedgers who want to take a position on whether the market price will rise or fall, without having to take ownership of the asset itself. The only thing that would exchange hands is the equivalent amount of money.

The sheer number of speculators and hedgers makes the futures market extremely liquid but volatile. The fast-changing prices can lead to risks, such as slippage – the potential for your order to be executed at a price that differs from the one you requested. This makes it important to have a risk management strategy in place.

With us, you could attach a guaranteed stop to spread bets and CFDs, that will remove the risk of slippage entirely. These stops are free to attach, and will only incur a small premium if triggered.

Learn more about managing your risk

How can you trade futures?

You can trade futures contracts in two ways with us:

1. For US-listed futures: use our web platform or mobile trading app to access pure-form futures contracts
2. For spread betting and CFD trading on futures: use our web platform, mobile app or MT4 to speculate on underlying futures prices

Open an account

When trading US-listed futures, you'll be obliged to uphold your side of the deal – whether that's buying or selling the underlying asset. At expiry, you'd either settle or roll over your contract.

You can trade futures contracts directly via our US options and futures platform. You’ll need to analyse the market and decide which futures contract you want to trade, at which expiry date. A lot of speculators will use the nearest date of expiry, as although it’s often the most expensive, it’s also the most actively traded and liquid.

Alternatively, you could trade on futures via CFDs and spread bets, in the same way as any other market. Our CFD and spread betting futures markets are designed to replicate the pricing and expiry dates of the underlying market, without you having to enter into a futures contract yourself.

You’d be speculating on whether the price of futures will rise or fall by a set date, and your profit would be determined by the extent to which you were correct. At expiry, we’d automatically roll your trade over to the next expiry, unless you tell us otherwise.

We also offer micro and mini futures, which enable you to take a smaller position than the standardised agreements.

Remember, when trading with leverage, your profits and losses are magnified and there’s a high risk of losing money rapidly. Always take steps to manage your risk.

Find out more about how to trade futures with us

Example of a futures contract

Say you want to buy US Crude – currently trading at $50. To hedge against the price rising, you opt to buy a July WTI futures contract at $50. At the time of expiry, the price had risen, which means you would’ve been able to buy 1,000 barrels of oil at the agreed price, regardless of the current value of the commodity. However, if the price had fallen, you would’ve been obliged to settle your contract at $50 (despite the lower market price).

Alternatively, you could open a long position on US crude futures with an expiry date for the end of the month. If the price of crude oil futures had risen at expiry, you’d have made a profit. However, if the price of oil had declined instead, you’d have made a loss.