Futures

A future is a contract between two parties about a transaction in the future. Both parties agree today on the price and the date on which something will be bought and sold. However, payment and delivery only occur at that later date. An example: A farmer and a mill agree in May that the mill will take delivery of one ton of wheat in October for 220 euros. If the price of wheat rises to 300 euros by then, the mill still only has to pay 220 euros. If it falls to 150 euros, the farmer still receives his 220 euros. The contract is binding for both sides, regardless of how the price develops.

Planning Certainty Against Price Jumps

The original purpose of futures is hedging. Companies need to be able to calculate what their raw materials will cost. An airline that locks in kerosene at a fixed price a year in advance can plan its ticket prices reliably. Without such contracts, every jump in the oil price would immediately wreck the entire calculation.

This security comes at a price. Whoever hedges forgoes the profit that a favorable price development would have brought. The airline in the example is annoyed if kerosene suddenly becomes cheap. It accepted this deliberately: it wanted no risk, not maximum profit. Hedging is therefore not a business deal but a kind of insurance.

Alongside this there is a second group of participants: speculators who never want to see a single ton of wheat. They buy and sell futures only to profit from price movements. This may sound superfluous at first, but it is useful. They ensure that there is always a counterparty available when a company wants to hedge.

Standardization, Exchange, and Margin Calls

Futures are traded on special exchanges, such as Eurex in Frankfurt or the CME in Chicago. For this to work, the contracts are strictly standardized. Quantity, quality, delivery month, and delivery location are all fixed in advance. An oil future, for example, always covers 1,000 barrels. This makes every contract interchangeable with every other and easy to trade.

When entering into the contract, one does not pay the full value of the commodity, but only a security deposit. This margin is often five to ten percent of the contract value. With 10,000 euros, one can therefore control a position worth 100,000 euros. This leverage effect magnifies both gains and losses to the same degree. A price change of just ten percent can wipe out the entire stake.

Between the parties stands a central counterparty, the clearing house. It settles gains and losses daily and books them from the accounts of the participants involved. If the security deposit is no longer sufficient, a margin call follows: one must add more money, or the position is forcibly closed. Incidentally, the vast majority of futures are closed out before the delivery date through an offsetting transaction. Actual wheat rarely changes hands.

Oil Prices, Bitcoin, and the Markets' Forward-Looking View

Futures constantly appear in the news, often without any explanation. When there is talk in the morning of US futures, this refers to contracts on stock indices such as the S&P 500. They are traded almost around the clock and are therefore regarded as an early indicator for the stock market opening. The much-cited oil price, too, is usually not a spot price but the price of a future on Brent or WTI oil.

Futures also play a role in the tech sector. Regulated futures contracts on Bitcoin have existed since 2017, allowing large investors to get involved without having to custody cryptocurrencies themselves. Data centers hedge electricity prices through energy futures – a point that has become more important given the high energy demand of AI systems.

A common misconception is confusing futures with options. An option grants the right to buy, a future the obligation. Someone who lets an option expire only loses the price paid for it. Someone who holds a future must deliver or take delivery. For retail investors, futures are an instrument with considerable risk of loss due to leverage and the obligation to post additional margin.