How Do Futures Work?

If you buy a future you have entered into an agreement to buy a particular asset at some time in the future, at a price agreed today.

If you sell a future you have entered into an agreement to sell the asset at some time in the future, at a price agreed today.

All futures are exchange-traded contracts and they're standardized in terms of:

  • The delivery date;
  • The amount of the “underlying” they relate to;    
  • The contract terms.

Futures contracts can be cash settled or require physical delivery. Most equity futures are cash settled, which means the contract requires a cash amount to be paid on the settlement day, reflecting the difference between the initial futures price and the price of the underlying share or index when the futures contract reaches maturity.

Futures contracts can also be freely bought and sold before the contract expires (i.e. before the point at which the underlying must be delivered or the contract cash settled). The value of the contract fluctuates before the settlement date to reflect the changing price of the underlying.

Finally, futures are geared, or leveraged, instruments, since positions can be taken in the underlying instrument by means of a relatively small cash outlay—the margin.

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