TL;DRA legally binding agreement to buy or sell a standardized asset at a predetermined price on a specific future date. This is the foundation of everything else in futures trading.
A futures contract is an agreement between two parties to buy or sell a specific asset at a specific price on a specific date in the future. One side agrees to buy (long), the other agrees to sell (short). Neither side can back out.
Unlike stocks, where you're buying ownership in a company, futures contracts are agreements about price. When you buy an ES futures contract, you're not buying a piece of the S&P 500. You're entering an agreement that pays you if the S&P 500 goes up and costs you if it goes down.
Every futures contract has standardized terms set by the exchange. The contract specifies exactly what asset is being traded, how much of it, when it expires, and the minimum price increment (tick size).
This standardization is what makes futures liquid. Because every ES contract is identical, buyers and sellers don't need to negotiate terms. You can enter and exit positions instantly because there's always someone on the other side.
Compare this to a private forward contract between two businesses, where every detail is custom negotiated. Futures took that concept and made it tradeable on an exchange.
Futures expire. Every contract has an expiration date, after which it settles and ceases to exist. Stock shares have no expiration. This means futures traders must either close their position before expiration or roll it to the next contract month.
Futures use leverage. You only need to post a small margin deposit (typically 3-12% of the contract's full value) to control the entire position.
Futures settle daily. Your gains and losses are credited or debited from your account at the end of every trading day through a process called mark to market. You don't wait until you sell to realize gains or losses.
Futures can be shorted just as easily as they can be bought. There's no borrowing, no locate requirement, and no uptick rule.
Hedgers use futures to manage risk. An airline might buy crude oil futures to lock in fuel costs. A farmer might sell corn futures to lock in a harvest price. These are the participants futures markets were originally designed for.
Speculators trade futures to profit from price changes. Day traders, swing traders, and algorithmic traders all fall into this category. Speculators provide the liquidity that hedgers need.
Most retail futures traders are speculators focused on equity index futures (ES, NQ) and energy (CL). The appeal is leverage, liquidity, tax treatment (60/40 long-term/short-term capital gains in the US), and nearly 24-hour trading.
A futures contract is listed by the exchange months before its expiration date. For equity index futures like ES and NQ, new contracts are listed quarterly (March, June, September, December).
The front month contract is the one closest to expiration and typically has the most volume and tightest spreads. As expiration approaches, traders roll their positions to the next contract month.
At expiration, the contract settles. Cash-settled contracts (like ES and NQ) simply credit or debit the final price difference. Physically-settled contracts (like crude oil or corn) require actual delivery of the commodity. Most retail traders close or roll well before this happens.
Going long ES
You believe the S&P 500 will rise. You buy 1 ES futures contract at 5,200.
Your contract is worth 5,200 x $50 = $260,000 in notional value. You posted roughly $12,000 in margin. If ES rises to 5,220, you've made 20 points x $50 = $1,000. If it falls to 5,180, you've lost $1,000. You can close the position at any time before expiration.
Hedging with futures
A wheat farmer expects to harvest 5,000 bushels in September. Current wheat futures for September delivery are trading at $6.50 per bushel.
The farmer sells 1 wheat futures contract (5,000 bushels) at $6.50. If wheat drops to $5.50 by September, the farmer loses on the physical crop but gains $5,000 on the futures position. The hedge locked in a price of $6.50 regardless of what happens in the market.
Treating futures like stocks and holding indefinitely
Futures expire. If you don't close or roll your position, it will settle. Know the expiration date and have a plan.
Not understanding the notional value of what you're trading
One ES contract controls $250,000+. One CL contract controls $70,000+ of crude oil. Calculate the notional value before you trade so you understand your actual exposure.
Thinking you can only go long
Futures are symmetrical. Shorting is just as easy as buying. If you think the market is going down, you can sell a contract to open and buy it back to close.