Futures terminology
You already know how to read a futures quote and place an order. The Broker’s Desk goes deeper, and it starts with words. Regulators and exchanges use precise terms, and most of the later lessons lean on them. This lesson collects the core vocabulary in one place, with definitions drawn from the CFTC glossary.
The contract itself
The CFTC defines a futures contract as an agreement to buy or sell a commodity for delivery in the future that:
- has a price set when the contract is made,
- obligates each side to perform at that price,
- is used to take on or shift price risk, and
- can be satisfied by delivery or by offset.
A forward contract is different. The CFTC describes it as a cash deal in which a commercial buyer and seller agree on delivery of a set quality and quantity at a future date, with terms more “personalized” than a standardized futures contract. The two parties decide the delivery time and amount between themselves.
The key contrast: futures are standardized and traded on an exchange; forwards are tailored private agreements.
Long, short, and offset
- Long: one who has bought a futures contract to open a position. A long futures position obligates the holder to take delivery if it is not closed.
- Short: the selling side of an open futures contract.
- Offset: closing a position with an equal and opposite trade in the same delivery month. Bought 2 March contracts? Sell 2 March contracts. Sold 1 June contract? Buy 1 June contract.
That is why the definition of a futures contract names both endings: a position you do not want to deliver on (or take delivery on) is closed by offset.
Clearing
A clearing organization (also called a clearing house or central counterparty) is the entity through which trades are cleared and settled. It also makes sure delivery procedures run properly and that trading is adequately financed. One registered with the CFTC is a Derivatives Clearing Organization.
A clearing member is a member of a clearing organization. A non-clearing firm’s trades must be settled through one.
Margin, leverage, and daily settlement
Margin is money or collateral deposited by a customer with a broker, by a broker with a clearing member, or by a clearing member with the clearing organization. The CFTC glossary is direct: margin “is not partial payment on a purchase.” It is also called a performance bond.
- Initial margin: the amount required when a position is opened.
- Maintenance margin: the amount that must stay on deposit. (The margin lesson later in this track covers margin calls in detail.)
Leverage is the ability to control a large dollar amount of a commodity with a comparatively small amount of capital. It cuts both ways: the federal risk disclosure in 17 CFR 1.55 warns that you can lose all the funds you deposit and can lose more than that.
Every trading day the clearing organization sets a settlement price for each contract month. Settlement prices are used for margin calls and for delivery invoice prices. Mark-to-market is the daily process of adding each position’s gain to, or subtracting its loss from, the account based on that settlement.
Months and market structure
- Delivery month (or contract month): the month in which a contract matures and can be settled by delivery.
- Front month (nearby): the nearest traded contract month.
- Back months (deferred): every month after the front month.
How those months are priced against each other tells you something about supply:
- Contango: each later month is progressively higher than the nearest month.
- Carrying charges (cost of carry): storage, insurance, interest, and other costs of holding the commodity. A market with higher prices for each later month is a carrying charge market, and when the price difference fully reimburses the holder for those costs it is called a full charge (full carry).
- Backwardation: later months are progressively lower. The CFTC points to inverted market for the same idea: nearer months above more distant months, “characteristic of markets with supply shortages.”
Open interest
Open interest is the number of contracts entered into and not yet closed by offset or fulfilled by delivery. Each contract has a buyer and a seller, but it counts once.
Made-up example:
| Trade | What happens | Open interest after |
|---|---|---|
| Ann buys 1 from Ben, both opening | One new contract exists | 1 |
| Cal buys 1 from Ann; Ann is closing, Cal is opening | The contract changes hands | 1 |
| Ben buys 1 from Cal, both closing | The contract is gone | 0 |
Who is in the market
- Hedger: takes positions in futures opposite to positions in the cash market, to reduce the risk of loss from an adverse price change.
- Speculator: does not hedge and trades to profit from correctly anticipating price moves. CME notes that speculators take the other side of many commercial trades and so provide liquidity.
- Scalper and day trader: in and out within one session. Position trader: holds for an extended period.
Key ideas
- A futures contract is standardized and ends by delivery or offset (equal and opposite trade, same month). A forward is a private, tailored deal.
- Trades clear through a clearing organization; non-clearing firms clear through a clearing member.
- Margin is a performance bond, not a down payment. Leverage magnifies gains and losses, and losses can exceed the deposit.
- Accounts are marked to market daily at the settlement price.
- Contango / carrying charge market: later months higher. Inverted / backwardation: nearby higher, a sign of tight supply.
- Open interest counts contracts still open, once per contract.