Futures: an obligation, not an option

A futures contract is a standardised exchange agreement under which the parties undertake to transact on a set date at a price fixed today.

The key word is undertake

Unlike an option there is no choice here. Both sides are obliged to perform, and the losing side's loss is capped by nothing.

What is actually bought

Not the asset but an obligation. Money equal to the asset's value is not required — only initial margin, a fraction of the position's full value, is posted: Initial margin: why a position can be closed without you.

Hence the built-in leverage: the result is computed on the full contract value while only the margin was put up.

Variation margin

The position's result is recalculated every day and debited or credited in cash. A loss cannot be sat out on paper: it leaves the account daily, and if funds run short the position is closed by force.

Expiration

A contract has an end date. The position is either closed before it or performed under the contract's rules — delivery of the asset or cash settlement.

Holding for the long term requires rolling into the next contract, and that roll has a price — Contango and backwardation: why a long futures position melts.

Who needs this

Those hedging a real position, and professional speculators. For an investor with a long horizon a futures contract contradicts the very design of the approach: daily settlement makes the result depend on interim fluctuations.

Related: Short positions and leverage: why risk here works differently.