Futures: contract, margin, expiry and roll

A futures contract is a standardized derivative contract traded on an organized venue and normally cleared through a clearing house. It creates a long position and a short position with obligations defined by the contract specifications. Before expiry, a position can be extinguished with an opposite transaction in the same contract; if it remains open, it is settled under the applicable rules.

The settlement formula is not universal. A physically delivered future may require delivery or taking delivery of the asset in the permitted grades, locations and windows. A cash-settled future instead ends with a monetary credit or debit calculated against a final settlement price or index: it does not involve physically buying or selling the reference.

The specifications that define the contract

The name of the underlying is not enough. Two futures linked to the same market can have different sizes, currencies, expiries and procedures.

For a linear contract quoted in points, let N be the number of contracts, M the monetary value of one point and P the price:

For a short, the sign of P&L is reversed. These formulas are shortcuts for linear contracts: fractional quotations, conversion factors, settlement currencies or inverse structures require the official formula.

Verifiable example. Two contracts are quoted at 4,200 points, are worth EUR 10 per point and have a tick of 0.5 points. Indicative notional is 2 × 4,200 × 10 = EUR 84,000; one tick across the two contracts is worth 2 × 0.5 × 10 = EUR 10. If the price falls by 12 points, the long's P&L is 2 × (−12) × 10 = −EUR 240. An initial margin of EUR 8,000 would not make EUR 8,000 the maximum loss: it measures required resources, not contract sensitivity.

Clearing, margin and mark-to-market

The clearing house enters the contractual chain under the market's rules. Futures margin is a performance bond: it is not a down payment on the underlying and not the balance of a loan equal to the difference between notional and the deposit. Initial, maintenance and additional requirements depend on the contract, portfolio, volatility, clearing member and intermediary; they can change.

Under mark-to-market, the daily settlement price determines credits and debits to the account. If equity no longer meets the requirement, a demand for funds, restrictions or liquidation may follow under the broker's rules and agreement. An estimated liquidation price is not a guaranteed stop: gaps, price limits, a thin order book and delays can produce a different execution and leave an outstanding balance.

Closing, rolling and settlement are three different actions

A roll can be executed as a calendar spread or with two separate orders; the latter also creates execution risk between the legs. The immediately following month does not have to be selected. Opening the same number of contracts does not guarantee the same exposure either: price, multiplier, remaining term, basis and liquidity may differ.

Expiry does not always coincide with one universal instant labelled “expiry.” Last trading day, expiration date, first notice day, first position day and delivery period can be different dates; some do not exist or are not relevant for cash-settled contracts.

Basis, curve and roll yield

Several expiries can be quoted for the same contract family. Their sequence forms the futures curve. Cyclepedia defines gross basis as b = F − S, the futures price minus the stated spot price. Other sources, including the CFTC for commodities in many contexts, use cash − futures: read the sign convention before comparing two figures.

The difference between two expiries is a calendar spread, not a futures-versus-spot basis. Contango and backwardation describe the shape of the curve for the expiries being compared; they are not universal forecasts of price direction.

Nor is the price difference between the contract being closed and the one being opened, by itself, an immediate loss. Separate:

• execution costs: bid-ask spread, commissions, slippage and risk between legs;
• changes in notional and in the characteristics of the new expiry;
• the contract's subsequent return along the curve and towards the settlement reference, a component often called roll yield;
• the specific rules of an index or fund that maintains futures exposure.

Why futures are used and what they do not guarantee

A hedger uses futures to offset part of the price risk of an asset, liability or future cash flow. A speculator instead takes exposure in pursuit of a return. The same position can serve different functions in a portfolio; the contract does not reveal a participant's intention.

A hedge does not automatically eliminate risk. An imperfect expiry, different grade or location, changes in basis, discrete sizing, margin and costs can leave a residual exposure. Likewise, a liquid futures family does not make every expiry liquid and does not guarantee an exit at the desired price.

Checklist before placing an order

1. Identify the contract, expiry, currency, unit, multiplier and tick.
2. Calculate notional, point value and loss under plausible scenarios.
3. Read the daily and final settlement methods, not only the ticker.
4. Check the calendar, time zone, liquidity and limits of the chosen expiry.
5. Distinguish required margin, available capital and potential loss.
6. Plan offset, roll or settlement without assuming broker intervention.
7. For a hedge, measure basis risk and the match between exposure and contract.

Sources

• U.S. Commodity Futures Trading Commission, Basics of Futures Trading — obligations, delivery or cash settlement and the possibility of losses exceeding initial capital.
• U.S. Commodity Futures Trading Commission, Futures Glossary — definitions of basis, calendar spread, cash settlement, margin, offset and roll-over.
• U.S. Commodity Futures Trading Commission, The Economic Purpose of Futures Contracts — standardization, clearing, offset, margin and hedging function.
• CME Group, Mark-to-Market — daily settlement price, P&L and margin adjustments.
• CME Group, Understanding Futures Expiration & Contract Roll — offset, rolling into deferred expiries and settlement.
• CME Group, Cash Settlement vs. Physical Delivery — daily versus final settlement and monetary versus physical settlement.
• CME Group, What is Equity Index Basis? — futures − spot basis, carry and convergence for equity index futures.
• U.S. Commodity Futures Trading Commission, Policy Statement on Price Differentials — grades, delivery locations, differentials and conditions for convergence.

Related pages

• Markets and financial instruments
• Derivative
• Notional amount
• Margin
• Futures expiry and settlement
• Futures basis
• Futures curve
• Contango and backwardation
• Futures roll
• Roll yield
• Spot market
• Commodities
• Liquidity
• Slippage