Home / Course / Module 3 / Forwards and Futures
Module 3 · Lesson 2 of 6Forwards and futures both lock in a price today for a trade that happens later. Forwards are private and flexible; futures are standardised, exchange-traded and settled in cash every day through margin.
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A forward contract is an agreement between two parties to buy or sell an asset at a fixed price (the forward price) on a fixed future date. Nothing changes hands today except the promise.
The key terms are simple.
Forwards are traded over the counter, so the size, date and terms can be tailored. The price of that flexibility is that each side must trust the other to honour the deal.
A jeweller expects to need 100 troy ounces of gold in three months. Spot gold is $2,000 per ounce. The jeweller (long) agrees with a bank (short) to buy 100 ounces in three months at a forward price of $2,040 per ounce.
Whatever one side gains, the other loses. A derivative like this is a zero-sum contract between the two parties (before costs).
A forward fixes the price, not the outcome. It removes uncertainty for the hedger and creates a gain or loss against the market price on the day.
A futures contract is a standardised forward traded on an exchange. The exchange fixes the details so that every contract of the same type is identical and can be bought and sold easily.
| Feature | Forward | Futures |
|---|---|---|
| Venue | Over the counter | Exchange |
| Contract size and dates | Negotiated | Standardised by the exchange |
| Counterparty | The other party directly | Clearing house |
| Profit and loss settled | At the end | Every day (mark-to-market) |
| Closing early | Hard, needs the other side to agree | Easy, trade an opposite contract |
Standardisation is a big deal. Because every contract is the same, buyers and sellers can find each other quickly, and prices are published openly. Most traders never plan to take delivery. They close the position before expiry by making the opposite trade: a trader who bought one contract sells one contract, and the net position is zero.
Settlement can be physical (the asset is delivered) or cash-settled (the difference is paid in money). Many commodity futures can be physically delivered, which is why speculators close out beforehand.
Futures use margin: a good-faith deposit held to cover possible losses. There are two levels to know.
Futures are also marked to market each day. At the end of every day the exchange works out the day's gain or loss on each position and moves that cash between accounts. Profits and losses are therefore paid in small daily instalments, not all at expiry.
A trader buys 1 gold futures contract covering 100 ounces at $2,000. Notional value = 100 x $2,000 = $200,000. Suppose initial margin is $10,000 (5% of $200,000) and maintenance margin is $9,000. All numbers are hypothetical.
| Day | Settlement price | Change per ounce | Daily gain or loss | Account balance |
|---|---|---|---|---|
| Start | $2,000 | none | none | $10,000 |
| Day 1 | $1,985 | -$15 | 100 x -$15 = -$1,500 | $8,500 |
| Day 2 | $1,990 | +$5 | 100 x $5 = +$500 | $9,000 if no top-up |
| Day 3 | $1,970 | -$20 | 100 x -$20 = -$2,000 | $7,000 if no top-up |
After day 1 the balance of $8,500 is below the $9,000 maintenance level, so a margin call arrives. To get back to the initial margin the trader must add $1,500 (the exact rule depends on the exchange and broker). A move of only 0.75% in the price ($15 on $2,000) produced a loss of 15% of the margin deposit: $1,500 / $10,000.
Margin is not a fee and not a cap on your loss. You can lose more than your initial margin on a futures contract. Leverage can lose money quickly, and a margin call can arrive at an awkward moment.
If gold is $2,000 today, why would a six-month future trade at a different price? Because holding the real asset until later has costs and benefits. This is the cost of carry.
For a storable asset like gold, the main costs are interest (money tied up in the metal could have earned interest) and storage and insurance. A simple approximation is:
Futures price = Spot price x (1 + interest rate x time) + storage costs
Spot gold = $2,000. Interest rate = 4% a year. Time = 6 months = 0.5 years. Storage and insurance ignored for simplicity.
If the futures traded far above $2,040, an arbitrageur could buy gold now, sell the future and lock in the difference. If it traded far below, the reverse. That pressure keeps futures close to this level.
The two names for the shape of the futures curve are worth knowing.
When a trader keeps a position beyond one contract's expiry, they roll it: close the near contract and open the next one. Rolling can carry a cost or a gain depending on the curve, and it matters for anyone holding futures long term.
Futures are the backbone of professional commodity markets, and the benchmark prices you see for gold are strongly linked to them. Even if you never trade a futures contract yourself, understanding them explains a lot.
Forgetting that gains and losses are paid daily, assuming the margin is the most you can lose, ignoring the expiry date, and not checking the contract size before sizing a position.
Next we look at an instrument with a very different shape of risk: Options Explained.
Only if you hold a physically settled contract through to its delivery process. Most speculators close the position before expiry with an opposite trade, and some contracts are cash-settled.
No. Margin is a deposit against possible losses. If the price moves far enough against you, losses can be larger than the initial margin.
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