Part 1 - Futures and forwards
23 November 2025 13:12
Futures contracts
Futures contract is not an option, but rather a contract into which two parties enter
- The contract sets out that one party will supply something for the other party at a particular price on a particular future date
Characteristics:
- Available on a wide range of assets
○ Could be financial securities i.e. shares or could be commodities like oil, gold (/other precious metals), food etc.
- Exchange traded (forward contracts not exchange traded)
- Certain specifications need to be identified in the contract:
○ Asset - what is the underlying?
For some assets, the specific qualities/'grades' may need to be specified
○ Quantity per contract
○ Price(s)
Could vary by grade
○ Delivery location(s) for physical assets
○ Delivery period(s)
- Settled daily (for futures rather than forwards)
○ Margin requirements
Convergence of future price and spot price
S0 is the current spot price (immediate purchase/sale price of the asset)
F0 is then the price today which would be written into a new forward contract if we were to enter into one
- F0, the delivery price which would be written into a new forward contract, changes over time (as does S0)
- Solid line represents the futures price (F0) which may vary over time
- Dashed lines represent spot price (S0) (correlation doesn't have to be perfect) but will also vary over time
○ When spot price goes up, price written into a forwards contract tends to go up (and vice versa)
○ F0 might track either below or above the spot price S0
- If there is a big difference between F0 and S0, you would sell what is overvalued and buy what is undervalued
○ i.e. if F0 were greater than S0, you would short the forward contract and buy the stock in the market
This arbitrage means both prices converge as time gets closer to delivery
Short vs long in a futures/forward contract
- Being short in a futures contract means you are selling the underlying
- Being long in a futures contract means you are buying the underlying
Margins
Feature which is different as between futures and forwards
- A margin is cash deposited by an investor with his/her broker (intermediary with the futures market)
○ Doesn’t have to be cash, could be other liquid assets or marketable securities:
Such as shares/bonds/golds etc.
But if they are non-cash securities, they are only adjudged as a proportion of their market value --> not worth as much
- The balance on the margin account is adjusted to reflect the daily settlement
- Margins minimise the possibility of loss or default on a contract
We have daily settlement by futures traders so if their position is getting worse, this eats into the margin and so we don’t have a
Fiance v2 Page 1
, ○ We have daily settlement by futures traders so if their position is getting worse, this eats into the margin and so we don’t have a
cumulation of the negative value, but rather there is a daily settlement of the negative
- Sometimes investors can earn interest on the balance of the margin account
- Exchanges set minimum levels for initial margins and maintenance margins
○ Some brokers require higher amounts but they can't allow lower amounts than the exchange-mandated minimum margin levels
Example - a futures trade
If an investor takes a long position in two December gold futures contracts on 5th June
- Contract size is 100 ounce
- Futures price is $1,250 per ounce i.e. F0
- Initial margin requirement is $6,000 per contract ($12,000 total)
- Maintenance margin is $4,500 per contract ($9,000 total)
○ i.e. if the margin balance falls below $9,000, it needs to be topped up to the initial margin level
As they have a long position, the holder needs to buy the underlying asset
Possible outcome:
- EOD futures price = new F0
○ At the end of day 1, the price per ounce has dropped $9 (lost value of $1,800)
- The change in margin balance for this investor is exactly opposite to the change in margin balance of the other party to the contract
(the person who is short in the future) --> their margin balance will have increased by $1,800 by the end of day 1
- After day 7, the margin account needs to be topped up to $12,000 given the loss leaves the margin account below the maintenance
margin level of $9,000
○ Margin call is the requirement to top up the margin account to the initial $12,000 (margin call value is $4,020)
Closing out and delivery
Most futures are closed out prior to delivery
- Process of closing out a futures trade is simply by entering into the opposite trade future
○ E.g. if you had bought a commodity future for December delivery you can can close out at any time by shorting one December
future for that commodity
- If a futures contract is not closed out before maturity, it is usually settled by delivering the assets underlying the contract
- When there are alternatives about what, where or when assets are delivered, these decisions are usually at the discretion of the party
who is trading short
- Some contracts (e.g., those on stock indices) are settled in cash rather than in assets
Futures vs forwards
Fiance v2 Page 2
23 November 2025 13:12
Futures contracts
Futures contract is not an option, but rather a contract into which two parties enter
- The contract sets out that one party will supply something for the other party at a particular price on a particular future date
Characteristics:
- Available on a wide range of assets
○ Could be financial securities i.e. shares or could be commodities like oil, gold (/other precious metals), food etc.
- Exchange traded (forward contracts not exchange traded)
- Certain specifications need to be identified in the contract:
○ Asset - what is the underlying?
For some assets, the specific qualities/'grades' may need to be specified
○ Quantity per contract
○ Price(s)
Could vary by grade
○ Delivery location(s) for physical assets
○ Delivery period(s)
- Settled daily (for futures rather than forwards)
○ Margin requirements
Convergence of future price and spot price
S0 is the current spot price (immediate purchase/sale price of the asset)
F0 is then the price today which would be written into a new forward contract if we were to enter into one
- F0, the delivery price which would be written into a new forward contract, changes over time (as does S0)
- Solid line represents the futures price (F0) which may vary over time
- Dashed lines represent spot price (S0) (correlation doesn't have to be perfect) but will also vary over time
○ When spot price goes up, price written into a forwards contract tends to go up (and vice versa)
○ F0 might track either below or above the spot price S0
- If there is a big difference between F0 and S0, you would sell what is overvalued and buy what is undervalued
○ i.e. if F0 were greater than S0, you would short the forward contract and buy the stock in the market
This arbitrage means both prices converge as time gets closer to delivery
Short vs long in a futures/forward contract
- Being short in a futures contract means you are selling the underlying
- Being long in a futures contract means you are buying the underlying
Margins
Feature which is different as between futures and forwards
- A margin is cash deposited by an investor with his/her broker (intermediary with the futures market)
○ Doesn’t have to be cash, could be other liquid assets or marketable securities:
Such as shares/bonds/golds etc.
But if they are non-cash securities, they are only adjudged as a proportion of their market value --> not worth as much
- The balance on the margin account is adjusted to reflect the daily settlement
- Margins minimise the possibility of loss or default on a contract
We have daily settlement by futures traders so if their position is getting worse, this eats into the margin and so we don’t have a
Fiance v2 Page 1
, ○ We have daily settlement by futures traders so if their position is getting worse, this eats into the margin and so we don’t have a
cumulation of the negative value, but rather there is a daily settlement of the negative
- Sometimes investors can earn interest on the balance of the margin account
- Exchanges set minimum levels for initial margins and maintenance margins
○ Some brokers require higher amounts but they can't allow lower amounts than the exchange-mandated minimum margin levels
Example - a futures trade
If an investor takes a long position in two December gold futures contracts on 5th June
- Contract size is 100 ounce
- Futures price is $1,250 per ounce i.e. F0
- Initial margin requirement is $6,000 per contract ($12,000 total)
- Maintenance margin is $4,500 per contract ($9,000 total)
○ i.e. if the margin balance falls below $9,000, it needs to be topped up to the initial margin level
As they have a long position, the holder needs to buy the underlying asset
Possible outcome:
- EOD futures price = new F0
○ At the end of day 1, the price per ounce has dropped $9 (lost value of $1,800)
- The change in margin balance for this investor is exactly opposite to the change in margin balance of the other party to the contract
(the person who is short in the future) --> their margin balance will have increased by $1,800 by the end of day 1
- After day 7, the margin account needs to be topped up to $12,000 given the loss leaves the margin account below the maintenance
margin level of $9,000
○ Margin call is the requirement to top up the margin account to the initial $12,000 (margin call value is $4,020)
Closing out and delivery
Most futures are closed out prior to delivery
- Process of closing out a futures trade is simply by entering into the opposite trade future
○ E.g. if you had bought a commodity future for December delivery you can can close out at any time by shorting one December
future for that commodity
- If a futures contract is not closed out before maturity, it is usually settled by delivering the assets underlying the contract
- When there are alternatives about what, where or when assets are delivered, these decisions are usually at the discretion of the party
who is trading short
- Some contracts (e.g., those on stock indices) are settled in cash rather than in assets
Futures vs forwards
Fiance v2 Page 2
