Futures Contract

A futures position is opened by posting initial margin, a performance bond sized to cover a plausible one-day adverse move. At the close of each session the exchange establishes a settlement price, and every open position is repriced against it. Gains are credited to the account in cash; losses are debited. If the balance falls below the maintenance margin threshold, the holder receives a margin call and must restore the account to the initial margin level, not merely back above maintenance.

The economic consequence is that the value of a futures contract resets to zero immediately after each settlement. Unlike a forward, whose mark-to-market value accumulates until maturity, a futures contract never builds a large unrealised claim. Profit and loss is converted into realised cash daily, which transforms credit risk into liquidity risk: the position remains solvent only as long as the holder can fund the calls.

Every contract term other than price is fixed by the exchange: quantity, quality or grade of the underlying, delivery months, tick size, last trading day, and whether settlement is physical or in cash. Standardization is what makes offsetting possible, because any long can be extinguished by selling an identical contract rather than by negotiating with the original counterparty.

On execution, the trade is novated: the clearinghouse becomes buyer to every seller and seller to every buyer. Its protection rests on a layered structure of margin, clearing member capital, a default fund and daily settlement, not on an unconditional guarantee. Open interest measures the number of contracts outstanding after offsets and is distinct from volume. As expiration approaches, arbitrage and the delivery mechanism pull the futures price toward the spot price, so the basis narrows toward zero.

Equity index futures provide low-cost synthetic exposure and are used to equitize cash, adjust beta, and hedge portfolios ahead of announcements. Government bond futures allow duration to be added or removed without trading the underlying bonds, with pricing complicated by the cheapest-to-deliver option. Short-term interest rate futures on reference rates such as SOFR are the market's principal instrument for expressing views on policy paths. Commodity producers and consumers use futures to lock in realised prices, while index investors face roll yield: rolling forward in a contango market drags on returns, whereas backwardation supports them.

In financial statements, futures used as hedges appear as derivative assets or liabilities at fair value, with margin balances typically shown within cash or receivables from brokers. Notional exposure and margin requirements are disclosed in the derivatives and risk management notes.

Be able to compute a day's mark-to-market as the change in settlement price multiplied by the contract multiplier and number of contracts, then trace the account balance through a sequence of days, identifying the day a margin call is triggered and its size. Be able to state the no-arbitrage price: the spot price carried forward at the risk-free rate over the contract's life, increased by storage and other holding costs and reduced by cash flows or benefits the holder of the underlying receives, such as dividends, coupons or a convenience yield.

Also be able to explain why futures and forward prices can diverge. When interest rates are positively correlated with the futures price, daily gains are reinvested at higher rates and losses funded at lower rates, which favours the long and pushes the futures price above the comparable forward price; negative correlation reverses the conclusion. With deterministic interest rates, the two prices coincide.