Futures — Part 1: how they work (margins, mark-to-market, delivery)

Educational content. Futures are leveraged instruments: they can cause losses exceeding the capital posted. Not a recommendation.

⟵ Start from the derivatives pillar · Go to Part 2: hedging with futures ⟶

Not an investment, a tool

A derivative isn't a "primary" investment: it's a tool for three purposes — exposure, risk transfer, leverage. The future is the most linear of these tools, and understanding its mechanics is the prerequisite for everything else.

Standardization = liquidity + operational efficiency

A future is a standardized forward: contract size, delivery (or cash settlement) and expiry are fixed. That uniformity is what makes it tradable on organized exchanges (CME, CBOE, CBT) with scale and liquidity. For large portfolios it's a huge advantage: to adjust a fund's equity exposure, instead of moving thousands of individual stock positions, you use a future — same exposure, minimal transaction costs, same-day settlement, without touching long-term holdings. It's "portfolio engineering": you tune duration or beta without dismantling anything.

Mutual obligation (and why mark-to-market is needed)

The key difference of futures versus options is one word: obligation. In a future both parties are bound — the buyer to take delivery/settle, the seller to deliver/settle. This mutual bond makes default risk central, and it's managed with daily mark-to-market: gains and losses are realized and transferred between parties every day. If the market moves against you, you post funds immediately; there's no debt quietly accumulating until expiry.

Margin as a "performance bond", and leverage

Opening a position, you don't post the full contract value but an initial margin: collateral, typically 2-10% of value. That's where leverage is born. Example: a $200,000 contract with $6,000 margin → a 1% move in the underlying (±$2,000) is about ±17-18% on margin; the leverage factor can exceed 35:1. Enormous capital efficiency, on one condition: daily monitoring of cash flows. The moment you fail a margin call, the position is force-liquidated, no questions asked.

Where the price comes from: the cost of carry

A future's price isn't arbitrary: it's the cost of carrying the asset to expiry.

F = S + interest (opportunity cost) − income (dividends/coupons)

If the cost of carry is positive, the future trades above spot (a situation called contango). Keeping the price aligned is cash-and-carry arbitrage: if the future is too expensive, a trader buys the asset spot, sells the future and finances the purchase at the risk-free rate, locking in a sure profit until pressure pushes prices back to equilibrium. This mechanism, active every second, prevents "free" profit and makes the market efficient.

Cost of carry by asset class

The general formula holds, but it changes with the type of underlying:

• Equity indices: F = index + interest − expected dividends — the basket's dividends reduce the cost of carry and can push the future belowspot.
• Government bonds: the cheapest-to-deliver logic kicks in — among deliverable bonds, the seller picks the most convenient one, and that drives the future's price.
• Currencies: the carry is the interest-rate differential between the two currencies (covered interest-rate parity): the FX future prices in the rate advantage or disadvantage.
• Commodities: on top of interest you add storage costs and any convenience yield from holding the physical good.

The margin call, in practice

Back to the example: a $200,000 contract, $6,000 initial margin. The broker also sets a maintenance margin (say $4,500). If a few bad sessions erode the margin below that threshold — say to $4,200 — a margin call fires: you must bring the account back to the initial margin (post about $1,800), immediately. If you don't, the position is force-closed at the market price, crystallizing the loss. That's why leverage demands reserve liquidity, not just a correct thesis: you can be right over the long run and still be liquidated in the short.

In short

Standardization (liquidity + efficiency), mutual obligation (managed via mark-to-market), margin as collateral that creates leverage (and a margin call that liquidates), price = cost of carry. Now that you know how it works, in Part 2 we look at the use that matters: hedging a risk — and why no hedge is perfect.

Sources

J. Hull, Options, Futures and Other Derivatives · CME Group — education · Borsa Italiana — glossary.

Educational content, not a recommendation. Leverage can cause losses exceeding capital.