How Commodity Futures Work

What a Futures Contract Is

If you're wondering how commodity futures work, here's the core idea: a commodity futures contract spells out that you'll buy or sell a fixed amount of a commodity for a certain price, on a set date in the future. You don't have to renegotiate any key terms every time you make a trade, since the exchange sets the contract size, specific quality, delivery point, and expiry date.

Take the COMEX gold futures: each contract represents 100 troy ounces. Or look at NYMEX WTI crude oil, where a contract covers 1,000 barrels. Because all these details are locked in by the exchange, you and other traders can quickly enter and exit the market with standardized contracts. There’s more on how futures prices stack up to spot prices in our article on spot vs futures prices.

Margin and Leverage Explained

With futures, you don’t pay for the whole contract up front. Instead, you post margin: a deposit the broker or a clearing house uses as security. To start a position, you pay what’s called initial margin. After that, the value of your contract can swing up or down: your account is adjusted daily for these gains and losses, using what’s known as variation margin.

If your losses drag your balance below a certain level, the broker will issue a margin call and ask you to top up your account. Futures give you leverage because you only have to put down part of the contract’s value, not the full amount. Just bear in mind, leverage makes both profits and losses bigger, for the same price move.

Worked Example: One Gold Futures Contract

Picture a scenario where one gold futures contract equals 100 ounces, priced at 2,000 per ounce. The total value comes to 200,000. If the exchange requires an initial margin of 10,000 (just as an example, not a real market rate), that’s what you deposit to open the position.

Now, if gold’s price moves up by 1 percent to 2,020 per ounce, your contract gains 2,000, which is 20 percent of your deposit. If the price falls by that same amount, you lose 2,000. Should your losses drop your account below the maintenance margin, your broker will ask you to add funds.

Expiry, Rollover and Settlement

Every futures contract expires on a fixed date. If you want to keep your market exposure past that date, you'll close your soon-to-expire position and open one in the next contract month, a process called rolling. What this does to your return is explained further in our page on roll yield in commodity ETCs. If you don't want to stay in, you simply close your position before expiry.

At expiry, the contract settles in one of two ways: cash settlement pays you (or takes from you) the difference between your contract price and the final market price. Physical delivery, on the other hand, means the actual commodity changes ownership, delivered to a specific place, agreed in the contract. Most people never take delivery.

Frequently asked questions