What are futures contracts and how do they work?

Futures contract trading plays an important role in both traditional finance (TradFi) and decentralized finance (DeFi), and it can bring high returns due to the use of leverage.

However, the same leverage can also work against traders, carrying elevated risks.

This guide explains futures contracts in both crypto and traditional markets, including stocks and commodities.

Learn what futures contracts are, how they work, and how to trade them, while also finding out which are the leading futures to watch and what risks you should take into consideration.

What are futures contracts

Futures contracts represent standardized agreements to buy or sell an asset at a set price on a specific date in the future.

This is the legal definition of a futures contract. In practice, however, most traders never buy or sell the underlying asset, as they close their positions before expiration, effectively offsetting the buy or sell obligation.

As a result, while the official definition refers to buying or selling an asset, most traders are effectively speculating on changes in the asset’s price.

The core purposes of futures contracts are hedging and speculation, and they are traded on regulated exchanges by both businesses and individual traders.

While companies often use futures to hedge against price swings in the commodities they produce/need, individual traders use them to speculate on price movements.

Futures contracts are regulated by the Commodity Futures Trading Commission (CFTC), an independent U.S. agency responsible for overseeing futures and options markets and promoting market integrity and transparency.

Key elements of futures contracts

The key components of a futures contract include the following:

• An underlying asset - The asset on which the contract is based
• The contract size - How much of the underlying asset the contract represents
• Tick size - The minimum price movement allowed
• Tick value - How much money a tick movement is worth
• Margin requirements - The initial margin is needed to open a position, and the maintenance margin is a minimum to avoid liquidation
• Settlement method – How the contract is settled, either through physical delivery or cash settlement. In crypto, perpetual futures rely on funding rates instead of a traditional settlement process.
• Expiration date - All futures have a fixed expiry except for perpetuals
• Leverage – A key feature of futures trading, enabled through margin, allowing traders to control larger positions with less capital.

How do futures contracts work

Futures contracts involve an agreement to buy or sell an asset at a predetermined price in the future, but in practice, most traders profit from price movements rather than exchanging the underlying asset.

Simply put, to trade futures, you have to follow these steps:

• Choose whether an asset's price will go up or down.
• Open a futures position with a small deposit called margin.
• If the price moves in your favor, the position is profitable; if it moves against you, it results in a loss.
• Using higher leverage increases both potential profits and the risk of larger losses.

The basics of futures pricing and margin

The initial margin starts your trade, maintenance margin keeps it alive, mark-to-market calculates your daily PnL, and leverage allows for bigger returns, but carries more liquidation risk.

Initial margin vs maintenance margin

The initial margin represents the amount of money needed to open a position, and the maintenance margin represents to minimum balance your account needs to keep that position open. If your losses push your balance below this level, you get a margin call or get liquidated.

Mark-to-Market (Daily PnL)

The daily PnL refers to your account being recalculated and adjusted in real time; your futures position if updated to reflect the current market price. When the price moves in your favor, money is added to your account, and when prices move against you, money is taken from the account.

Leverage and liquidation risk

Leverage allows you to control a larger position than your actual capital would normally permit, offering higher potential returns but also greater risk. For example, with 10× leverage, $100 controls $1,000 worth of futures.

However, as leverage increases the size of your trade, small price movements can trigger huge losses. If losses are large enough to drag your balance below the maintenance margin, the exchange will liquidate you (close your trade) to prevent a negative balance. The more leverage you use, the higher the risks of getting liquidated.

Settlement types

Settlement types for futures contracts are the following:

• Cash-settled futures - At expiration, the contract is settled in cash; the exchange calculates the difference between the final settlement price and the futures price you entered the contract at; profits/losses are credited/debited to your margin account
• Physically delivered futures - The actual underlying asset (commodity) is delivered at expiration; the buyer pays the contract price and receives the asset, while delivery happens based on exchange-defined rules

Who runs futures markets

Futures markets are run by regulated exchanges (CME Group, ICE, and Eurex), and risk is controlled via a central clearinghouse (like CME Clearing).

Types of futures contracts

The types of futures contracts are the following:

Futures contracts in crypto

There are two types of futures contracts in crypto:

• Crypto futures contracts - Futures contracts that have a fixed expiration date, with price converging to spot at settlement; they have no funding rates, and are common in regulated futures markets, used for hedging and structured strategies.
• Perpetual futures contracts - Designed to trade like spot, but using leverage and funding rates to keep the price near spot; they can be held indefinitely and are more sensitive to liquidations during volatile periods. Perps are more flexible than futures contracts, but riskier.

TRADE CRYPTO FUTURES CONTRACTS

Expiry rules in crypto futures

Dated crypto futures expire on a fixed date and time, with common expiries being weekly, monthly, or quarterly. The expiration time is typically aligned with UTC and set by the exchange.

When crypto contracts expire, the following events take place:

• Trading stops at expiration time.
• The exchange calculates a final settlement price.
• All open positions are automatically closed.
• Profit/loss is settled in cash.
• The contract is delisted.

Most traders close their positions before expiry; however, they can roll into the next contract to maintain exposure.

Cash settlement vs delivery

Cash-settled crypto futures are the most common, and the P&L is paid in USD or stablecoins. Cash settlement avoids custody and wallet logistics, and involves simpler regulation while being easier for institutions.

Physically delivered crypto futures are rarer, and settlement involves BTC/ETH delivery. They require custody infrastructure (custodial wallets, exchange accounts).

Holding time and risk

You can hold the crypto futures contract until the expiration date if you meet margin requirements, but most traders close/roll positions before expiry to avoid settlement. You can hold the perp contract indefinitely if you maintain your margin.

When the margin falls below maintenance requirements, your position will be automatically closed. High leverage boosts losses, and if your account cannot cover potential losses, the exchange closes your position to prevent a negative balance.

Funding costs are periodic payments exchanged between longs and shorts to keep the perp price close to spot. If the contract trades above spot, longs pay shorts, and if it trades below spot, shorts pay longs. Only perpetual futures have funding rates.

Considering that crypto markets trade nonstop, positions are exposed to price swings frequently, including overnight/weekends. Leverage amplifies the effects of sudden moves, and risk is higher for retail traders who cannot monitor the markets all the time.

To manage risks, traders perform the following:

• Reduce leverage
• Use stop-loss
• Roll dated futures before expiry
• Monitor funding payments for perps

Rolling futures contracts

Rolling futures contracts means closing your position before the contract's expiration and opening the same position in a contract that expires later.

Traders roll contracts for the following reasons:

• To avoid expiration - Rolling futures contracts allows you to keep your exposure without going through settlement
• To maintain market exposure - If you want ongoing exposure to an asset, you will need contracts that don't expire; rolling contracts ensure your positions stay active across expiries
• To hedge ongoing risk - You may need to keep hedges active over multiple months, and rolling prevents gaps in coverage when the near-month contract expires
• To manage liquidity and pricing - Near-expiry contracts have different liquidity/spreads, and rolling allows you to move into contracts with better liquidity and pricing

Most traded and most liquid futures contracts

The most liquid futures contracts are micro versions of S&P 500, 10-Year T-Notes, oil, Euro Stoxx 50, gold, Euro FX, CBOE Volatilty Index, CME Bitcoin futures.

The most liquid futures contracts involve the following features:

• Easily bought/sold without triggering high price changes
• Traded frequently with a high number of contracts traded daily
• Tight bid-ask spreads, which means that the price difference between buyers/sellers is small

Liquidity of futures contracts is important due to:

• Easier enter/exit positions - High liquidity allows you to buy/sell large positions without affecting the market.
• Lower trading costs - Tight bid-ask spreads trigger lower costs for trades.
• Accurate pricing - Liquid contracts mirror real-time supply and demand, less slippage; they make it easier for traders/hedgers to price risk properly
• Better leverage and risk management - Higher liquidity decreases liquidation risks; in case of lower liquidity, exiting a large position can impact prices

The best futures to trade have the following features:

• High liquidity
• Clear behavior
• Reasonable margin
• Transparent volatilty
• Track popular, well-established assets

The most traded futures contracts are listed on CME Group based on daily volume and open interest.

How to trade futures contracts - A beginner's guide

To buy futures contracts, you have to follow these simple steps:

Choose a venue; it can be a regulated broker, exchange or a crypto platform like Binance, OKX, and others.

• Set up an account on the chosen platform and complete the KYC verification if required
• Pass risk checks
• Deposit funds (USD, stablecoins, or crypto)
• Place an order

To place an order, you have to:

• Decide the order type (market order, limit order, stop order)
• Enter the contract size and leverage if the venue allows it
• Confirm and execute trade

TRADE CRYPTO FUTURES

Risk management essentials

Key risk management solutions are the following:

• Position sizing
• Stop loss
• Max daily loss
• Avoiding overleverage
• Making sure the futures contract has high liquidity

Common beginner mistakes when trading futures include the following:

• Ignoring margin requirements
• Failing to set stop losses
• Confusing micro contracts with full-size contracts
• Overtrading leading to increased fees, slippage
• Using too high leverage, which comes with higher liquidation risks
• Ignoring expiry or rollover rules
• Neglecting the liquidity of a futures contract
• Overlooking funding costs, which can accumulate, surpassing profits
• Emotional trading
• Ignoring overnight/weekend risks
• Not defining position size, max loss, or target profit

Example workflow - Trading oil futures contracts

When trading oil futures contracts, traders watch the following:

• Inventory and supply-demand data - Weekly reports from EIA, API
• Macro-economic indicators - GDP, industrial production, manufacturing indexes, US economic data, USD index, interest rates
• Volatilty and market sentiment
• Other geopolitical indicators, sanctions, which can affect supply/exports

After analyzing the indicators above, traders choose a platform like CME Group which provides access to E-mini Crude Oil and Micro Crude Oil futures contracts, and start trading.

Micro futures, low margin, and getting started small

Micro futures contracts are smaller versions of a standard contract and allow beginners to get started with lower amounts and associated risks. Smaller contracts require less capital and can usually offer more flexibility for managing risks or testing strategies.

For instance, Charles Schwab provides a lengthy list of micro futures contracts on its platform, including Micro E-mini S&P 500, Micro E-mini DOW, Micro Nikkei, CME Micro Bitcoin, Micro Gold, and others.

Brokers and low-margin marketing claims

Some brokers advertise "$50 margin micro futures contracts," but this is only the minimum intraday margin, and not the real risk. Margin requirements vary by broker, market conditions, and volatilty, and they can be raised by sudden market moves or news.

Futures are highly leveraged, and even small price moves can exceed the posted margin and trigger losses/liquidations. Low maring doesn't necessarily mean lower risks.

How can I get funded to trade futures contracts?

You can trade futures contracts using funded accounts from prop trading firms (disciplined and with risk-control), which offer capital if you pass their evaluation. This usually includes proving that:

• You can trade profitably under the trading rules (limits on daily loss, position size, trading hours)
• Your account must not fall below the set loss level
• You can avoid gambling or oversized trades

Profits are split between you and the prop firm and payouts are allowed after meeting minimum trading days/profit targets.

Regulation and legal classification

Futures contracts are regulated based on jurisdiction and product and are regulated to:

• Control risk
• Protect traders
• Keep markets fair

Are futures contracts securities?

Futures contracts are derivatives or commodities, and in the US, they are generally treated as commodities, not securities. They are regulated by the Commodity Futures Trading Commission (CFTC) and not the SEC. Futures on stocks, bonds or BTC are legally commodity futures.

The key exception are security futures - single-stock futures and narrow-based index futures, regulated by the CFTC and SEC.

Regulated futures contracts and CME

Futures contracts are regulated by:

• Regulators like CFTC in the US and ESMA in EU/UK
• Regulated exchanges like CME, ICE, Eurex
• Central clearing, clearinghouses

Crypto futures on regulated exchanges like CME follow the same strict rules to avoid market manipulation, excessive speculation, systemic risk, and crypto futures on offshore platforms may have lighter or different regulations.

CME-style markets matter because they provide higher transparency and lower risk for traders.

TRADE CRYPTO FUTURES

Taxes and reporting

Futures contracts are taxed differently in accordance with the country they're traded in.

For instance, in the US, futures contracts are included in the "Section 1256 contracts" which includes:

• Regulated futures contracts
• Foreign currency contracts
• Nonequity options
• Dealer equity options
• Dealer securities futures contracts

Section 1256 contracts are specific financial instruments, especially derivatives, that receive a special tax treatment under the US IRS, subject to mark-to-market accounting rules and a "60/40" tax rate split, regardless of how long they are held.

Conclusion

Futures contracts are standardized agreements to buy or sell an asset at a set price on a specific date in the future, but in practice, most traders never buy or sell the actual asset as they close their position before expiration. Futures contracts purpose is hedging and speculation.

In crypto, futures contracts have an expiration date, and perpetual futures contracts can be held indefinitely, lacking an expiry date.

Beginners should approach futures contracts trading with high caution, use regulated platforms or exchanges to minimize risk, follow all rules involved in trading futures, and use low leverage.

As a beginner, you should start with smaller-sized contracts, like mini futures contracts, and make sure to learn all contract specs to ensure it has enough liquidity and high trading volume.

FAQ on futures contracts

What are futures contracts?

Futures contracts are agreements to buy or sell an asset at a price set on a specific date in the future. However, most traders never buy or sell the asset, because they close their position before expiration, rolling out to another futures contract.

How do futures contracts work?

Futures contracts involve a deal to buy/sell an asset later at a price previously agreed upon, but instead of exchanging the asset, you make profits from its price volatilty. To trade futures, you have to choose whether the price of the asset will go up/down, and open a futures position with a small deposit. If the price moves in your favor, you win; if it moves against you, you lose.

When do futures contracts expire?

Futures contracts expire at a date set by the exchange.

Do futures contracts expire?

Yes, futures contracts expire at a date set in the future by an exchange.

How long can you hold crypto futures contracts?

You can hold crypto futures contracts until their expiration date.

What happens when crypto futures contracts expire?

When the crypto futures contracts expire, your profit/loss is determined by the difference between your entry price and the final settlement price. If the price moved in your favor, you make a profit; else, you record a loss. You can close or roll your position into another contract before the expiration date to maintain exposure.

How to trade futures contracts?

To trade futures contracts, you must first choose a regulated platform, analyze the contracts' liquidity and other relevant features, sign up on the platform, verify your account, make a deposit, place an order, enter the contract size and leverage, and confirm the order.

Are futures contracts securities?

No, futures contracts are generally not considered securities, but derivatives or commodities.