Futures Trading Theory and Basic Functions/Terminology
Core Ideas
A futures contract is a standardized, exchange-traded agreement to buy or sell a specified quantity of a commodity or financial instrument at a future date. The exchange standardizes contract size, quality, delivery months, and tick size; the clearinghouse becomes the counterparty to every trade through novation. A position is opened by buying (long) or selling (short) and is usually closed by an offsetting trade rather than delivery.
Key terms include spot/cash price, futures price, basis (cash minus futures), contango (futures above cash), backwardation (futures below cash), volume, open interest, settlement price, tick, and daily price limit. Margin in futures is a performance bond, not a down payment or loan; it is marked to market daily. Prices converge toward cash at delivery.
Traps
Questions often confuse volume with open interest, settlement price with closing price, and initial margin with maintenance margin. Delivery is not mandatory for most traders because offset is available. A margin call restores equity to the required level and is not interest-bearing credit.
Rule of Thumb
Tick value = tick size × contract size. If a contract covers 50,000 units and the minimum price fluctuation is 0.01 cent per unit, one tick is 50,000 × $0.0001 = $5.