What Are Futures — Margin and Leverage

Futures are standardized contracts to buy or sell a specific asset at a pre-set price on a set future date.

For example, if you contract now to 'buy one barrel of crude oil at $80 in three months,' you trade at $80 in three months regardless of the actual price then. If the actual price is $90, the buyer gains; if $70, the seller gains.

Futures exist on a variety of underlying assets — commodities (crude oil, gold, agricultural products), stock indexes, currencies, interest rates, and more. They trade in standardized form on exchanges, with a clearinghouse guaranteeing settlement in the middle.

The core of futures is margin. This is not 'borrowing money' but 'collateral' that shows you can bear losses.

Initial margin is roughly 3–12% of the contract's notional value, varying by product. In other words, you can hold a contract with a notional value of about $74,000 with a few thousand dollars of margin.

Maintenance margin is roughly 50–75% of the initial margin; if your account balance falls below this, a margin call (a demand for additional margin) occurs. If you cannot meet it, you are forcibly liquidated.

Futures settle gains and losses every day based on the closing price. This is called daily settlement (mark-to-market). If you gain, it goes into your account; if you lose, it goes out.

Because you move a large notional value with small margin, even a small price move makes your gain or loss several times larger relative to your margin. This is the leverage effect.

For example, if margin is 10% of notional value, a 5% move in the underlying becomes about a 50% gain or loss relative to your margin. If the direction is right, you gain big, but if it's wrong, the margin melts in an instant, leading to a margin call and forced liquidation.

Both the appeal and the danger of futures come from leverage. Being able to hold a large position with a small amount of money means losses can grow just as fast.

In particular, if you get the direction wrong, losses can exceed your margin, and it is possible to end up owing more than your principal.

Futures are the exact opposite in character to the long-term recurring and lump-sum investing this service emphasizes. The first step is to clearly understand that futures are a tool that requires a short horizon, high risk, and precise risk management.