What Is a Futures Contract? How Futures Trading Works
Every time the news says "oil futures jumped," it's talking about a 300-year-old farmer's trick that now moves trillions of dollars — and can double your money or vaporise it before lunch.
By Pavel Penev, MScFounder, TradeWize · 10+ years trading the marketsThe short answer
A futures contract is a binding agreement to buy or sell a set amount of something — oil, gold, wheat, a stock index — at a price you fix today, for delivery on a set date in the future. Both sides are locked in: one must buy, the other must sell, no matter where the price has gone by then. You put down a small deposit (margin) to control the whole thing, which is where the money — and the danger — comes from.
You have heard the phrase "oil futures" a hundred times without anyone ever explaining it. It sounds like something traded by men in suspenders screaming at each other in a pit, and for the better part of a century that's exactly what it was. But the idea underneath is almost embarrassingly simple, and — plot twist — it wasn't cooked up by a bank. It was invented by farmers who were tired of betting the whole year on whether it would rain. Strip away the jargon and a futures contract is a promise about a price — made now, kept later.
It started with farmers, not finance
Picture a corn farmer in spring. The crop won't be ready until autumn, and she has no idea what corn will sell for by then. If prices crash, she's ruined. On the other side of the deal sits a cereal company that has the opposite fear: if corn prices spike, its costs blow up. Both of them would happily give up the chance of a windfall in exchange for certainty. So they strike a deal in spring: a fixed price for a fixed amount of corn, delivered in autumn. The farmer knows what she'll earn; the company knows what it'll pay. The weather can do whatever it likes — the price is already settled.
That deal is a futures contract, and the instinct behind it is ancient. The first proper futures exchange was the Dōjima Rice Exchange in Osaka, up and running in the 1730s — the same Japanese rice market that, not coincidentally, gave us the candlestick chart. Traders there worked out that you could standardise these promises and buy and sell them, and the modern multi-trillion-dollar futures market is just that idea with fibre-optic cables. The core purpose has never changed: futures let someone who doesn't want price risk hand it to someone who does.
What's actually in the contract
The reason a farmer's private handshake became a global market is standardisation. An exchange takes the four things that would otherwise need negotiating and freezes three of them solid, so the only thing left for buyers and sellers to argue about is the price. That's what makes a contract fungible — tradable by millions of strangers who never meet:
One standard crude-oil contract. The underlying, the size, and the delivery date are fixed by the exchange — you don't get to tweak them. All that's left to trade is the price. Multiply size by price and you get the notional: the full value of oil that one contract puts you on the hook for.
- The underlying — what's being traded. It can be a physical commodity (crude oil, gold, wheat, natural gas) or something financial (the S&P 500, a government bond, even Bitcoin).
- The contract size — a fixed quantity. One standard crude contract is 1,000 barrels; there's no 640-barrel option, only whole contracts. Futures don't do half-measures, which is half of why they feel intimidating — the units are deliberately chunky.
- The price — the one number left to negotiate, set by supply and demand right up to the second you trade.
- The expiry — a fixed delivery month. Every contract is born with an end date stamped on it, like a carton of milk, and once it settles it simply ceases to exist. This is the feature that makes futures feel like a ticking clock.
You're trading the contract, not the barrels
Here's the thing that trips up every beginner: the overwhelming majority of futures traders never touch the actual commodity. They buy a contract expecting the price to rise, then sell that same contract to someone else before it expires, pocketing (or eating) the difference. The oil, the wheat, the gold — it's an abstraction they're betting on, not a warehouse they're filling. The contract itself is the product being traded.
Two people, opposite reasons
Every futures trade has two sides, and they're usually there for completely different reasons. One person is trying to get rid of risk; the other is volunteering to take it on in the hope of a profit. Both are essential — and understanding which one you are is the difference between a tool and a casino.
The hedger
Wants certainty, not profit
- An airline locking in jet-fuel costs so a war in the Gulf can't wreck its budget.
- A farmer fixing the price of a harvest that isn't grown yet.
- A chocolate maker nailing down cocoa before prices can run.
- Happily gives up a possible windfall to sleep at night.
The speculator
Wants profit, accepts risk
- A trader betting oil rises, with no intention of ever seeing a barrel.
- A fund using leverage to amplify a short-term view on gold.
- Provides the liquidity the hedger needs to offload their risk.
- Takes on the price swings the hedger is desperate to avoid.
It's tempting to cast the speculator as the villain, but the market genuinely needs them. Without traders willing to take the other side, the airline would have no one to sell its risk to. Speculators are the shock absorbers — they get paid (when they're right) for absorbing the uncertainty that businesses can't afford to carry. The catch is the mechanism that lets them do it at scale, which is also the thing that makes futures so easy to blow up an account with.
The part that makes futures dangerous: leverage
You do not pay the full value of a futures contract to trade it. You post a small deposit — called margin — that the exchange holds as a good-faith performance bond, and that deposit controls the entire notional value. This is leverage, and it is the single most important thing to understand about futures, because it's what turns a modest move into a life-changing gain or a margin call.
Put down roughly 10% and you control the full $75,000 contract (real margins are often even lower). Now a mere 5% move in the oil price — the kind of thing that happens on a quiet Tuesday — becomes a 50% swing in your account. Up or down. Leverage doesn't take sides.
Look hard at both cards, because beginners only ever picture the green one. Yes, a 5% rise in oil hands you a 50% return on your margin — intoxicating. But the identical 5% fall hands you a 50% loss, and the move that gets you there is completely routine. Oil moving 5% is not a black-swan event; it's a slow news day. That's the deal futures offer: they take the ordinary, survivable wiggles of a market and multiply them into extraordinary, sometimes un-survivable swings in your account.
Margin is a trip-wire, not a down payment
A house down payment is money you've spent. Futures margin is money the exchange can demand more of. Futures are "marked to market" every single day: if your position loses money, that loss is pulled from your account overnight. Drop below the required margin and you get a margin call — top up now, or the broker closes your position at the worst possible moment, whether you're awake to argue or not. Leverage giveth, and the daily settlement taketh away.
Learn it by doing
Reading about it is one thing — it clicks when you do it. Learn it hands-on with free, interactive lessons on TradeWize.
Try the free lesson →No, 1,000 barrels won't arrive on your porch
A reasonable fear on hearing "you're obligated to buy 1,000 barrels of oil" is a mental image of a tanker truck reversing up your driveway. In practice, two things prevent it. Most contracts are cash-settled — especially financial futures like the S&P 500, where there's nothing physical to deliver, so the contract just pays out the difference in cash at expiry. And even for physical commodities, traders close their position before the delivery window opens, passing the hot potato to someone else. Take delivery and you'd need somewhere to actually put the stuff — which is precisely the nightmare that produced one of the strangest days in market history.
On April 20, 2020, the price of a U.S. oil futures contract went negative — bottoming near minus $37 a barrel. Sellers were paying buyers to take oil off their hands. The world was locked down, nobody needed crude, and the storage tanks at the delivery point in Cushing, Oklahoma were full. Whoever still held the expiring contract was legally obligated to take delivery of physical oil they had absolutely nowhere to store, so they paid to escape. It was a once-in-a-lifetime glitch — but it was also the entire concept of futures, laid bare: a contract is a real obligation with a real deadline, not a number on a screen. For a few brutal hours, an entire generation of traders learned that "obligated to take delivery" was never a metaphor.
Contango, backwardation, and the shape of the curve
Because a contract exists for each future month, you can line those prices up and see the market's mood as a curve. It usually slopes one of two ways, and the two words for it sound like spells but describe something simple: is the market more worried about getting the commodity now, or later?
Contango: each later month costs more than the last — the normal state, reflecting the cost of storing and financing a commodity until then. Backwardation: later months cost less, which means the market is paying a premium for the barrel it can have right now — the classic fingerprint of a supply scare.
This isn't trivia — it has a real cost. Because contracts expire, anyone holding a position long-term has to keep "rolling" it: selling the expiring contract and buying the next month's. In contango, that next month is pricier, so every roll quietly bleeds a little money. It's why commodity ETFs that hold futures — the ones that let ordinary investors "buy oil" — can drift lower even when the spot price of oil is flat. The headline price went nowhere; the roll ate the difference. Contango is the tax you didn't know you were paying.
Futures vs options vs CFDs
Futures get lumped in with a couple of other leveraged instruments people mix them up with. The distinctions are cleaner than they look, and they mostly come down to one question: are you obligated, or do you just have the option?
| Instrument | Are you obligated? | Where it trades | Best known for |
|---|---|---|---|
| Futures | Yes — both sides must transact at expiry | A regulated exchange, centrally cleared | Hedging commodities and indices; deep, transparent markets |
| Options | The buyer has the right, not the obligation | A regulated exchange | Paying a fixed premium for asymmetric, one-way bets |
| CFDs | Yes — but it's a private bet with a broker | Over-the-counter, broker to client (banned for U.S. retail) | Easy retail access to leverage on almost anything |
The headline difference: a futures contract binds both parties to the trade; an option gives its buyer a choice. A CFD mimics a future's payoff but is a contract with your broker, not an exchange.
In one line each: a future is a binding, exchange-traded promise to trade at a set price. An option is the right — but not the duty — to do so, bought for a fee. A CFD is a broker-run contract that pays you the price difference, popular precisely because it's easy to access, and restricted in some places for exactly the same reason.
So should you trade them?
Futures are a genuinely brilliant tool. They let a real business hand off a risk it can't afford, they're among the most liquid and transparent markets on Earth, and they let a trader express a precise view with efficient use of capital. None of that is hype. But the same leverage that makes them powerful makes them unforgiving: the market doesn't need to be wrong for long to wipe out a thinly-margined position, and "I was right eventually" is cold comfort after a margin call closed you out at the low.
Leverage is a magnifying glass. Point it at a good decision and it makes you rich; point it at a bad one, or just an unlucky week, and it burns the account down. The instrument is neutral. The size of your position is not.
If you're curious about futures, the sane path is to learn the mechanics cold and practise them where a margin call costs you nothing but pride. Trade a few dozen contracts on a simulator first. Feel what daily marking-to-market does to your nerves. Watch a 5% move turn into a 50% account swing when it's not your rent on the line. Then decide whether the real thing is a tool you want in your hands — or one you're happy to leave to the airlines and the pros.
What is a futures contract in simple terms?
It's a binding agreement to buy or sell a set amount of something — like oil, gold, or a stock index — at a price agreed today, for delivery on a specific future date. Both sides are locked in: one must buy and the other must sell at that price when the contract expires, regardless of where the market has moved. It started as a way for farmers and manufacturers to lock in prices in advance and remove uncertainty.
How do futures make (or lose) money so fast?
Leverage. You only post a small margin deposit — often around 5–10% of the contract's full value — but you control the entire amount. So a small percentage move in the underlying price becomes a much larger percentage move on your deposit. A 5% move in the asset can be a 50% move in your account. That amplification works identically in both directions, which is why futures can be so profitable and so quick to blow up an account.
What's the difference between futures and options?
Obligation. A futures contract binds both the buyer and the seller — at expiry, the trade must happen at the agreed price. An option gives its buyer the right but not the obligation to trade, in exchange for an upfront fee (the premium). If an option ends up worthless, the buyer simply walks away and loses only the premium. A futures holder can't walk away without closing the position, and their potential loss isn't capped to a premium.
Do I have to take physical delivery of the commodity?
Almost never. Most financial futures (like stock-index futures) are cash-settled — they just pay out the difference in cash at expiry, since there's nothing physical to deliver. For commodity futures that can be physically delivered, traders close their positions before the delivery window opens, so they're never actually obligated to receive the goods. The one way to get stuck with delivery is to hold a physically-settled contract all the way to expiry — which is how oil futures famously went negative in April 2020.
What is margin in futures trading?
Margin is a good-faith deposit the exchange requires to open a futures position — a performance bond, not a partial payment. Futures are marked to market daily, so gains and losses are settled to your account every day. If losses eat into your margin and it falls below the required level, you get a margin call: you must add funds immediately, or your broker will close the position for you. So margin isn't money you've spent — it's money the exchange can demand more of.
Are futures a good idea for beginners?
Generally, no — not with real money first. Futures are powerful but unforgiving: the built-in leverage means an ordinary market move can produce an extraordinary loss, and daily margin calls can force you out at the worst moment. They're excellent for hedging and for experienced traders who size positions carefully, but a beginner is far better off learning the mechanics on a risk-free simulator until a 50% account swing stops feeling abstract.
Trade futures where a margin call costs you nothing
Reading about leverage is the safe half. TradeWize's futures track teaches margin, the curve, and position sizing hands-on — and you practise on live-feel charts with virtual coins, so your first blown-up account is free.